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fljr^e  €conomic  ©ssapa 


THE  CAUSE  AND  EXTENT  OF  THE  RECENT  INDUS- 
TRIAL PROGRESS  OF  GERMANY.    By  Earl  D.  Howard. 

THE  CAUSES  OF  THE  PANIC  OF  1893.  By  William  J. 
Lauck. 

INDUSTRIAL    EDUCATION.     By  Harlow  Stafford  Person, 
Ph.D. 

FEDERAL  REGULATION  OF  RAILWAY  RATES.  By  Al- 
bert N.  Merritt,  Ph.D. 

SHIP  SUBSIDIES.  An  Economic  Study  of  the  Policy  of  Sub- 
sidizing Merchant  Marines.     By  Walter  T.  Dunmore. 

SOCIALISM:  A  CRITICAL  ANALYSIS.     By  O.  D.  Skelton.      | 

INDUSTRIAL  ACCIDENTS  AND  THEIR  COMPENSATION. 
By  Gilbert  L.  Campbell,  B.  S. 

THE  STANDARD  OF  LIVING  AMONG  THE  INDUSTRIAL 
PEOPLE  OF    AMERICA.     By    Frank  H.   Streightoff. 

THE     NAVIGABLE    RHINE.     By  Edwin  J.  Clapp. 

HISTORY  AND  ORGANIZATION  OF  CRIMINAL  STATIS- 
TICS IN  THE  UNITED  STATES.  By  Louis  Newton 
Robinson. 

SOCIAL  VALUE.    By  B.  M.  Anderson,  Jr. 

FREIGHT  CLASSIFICATION.     By  J.  F.  Strombeck. 

WATERWAYS  VERSUS  RAILWAYS.  By  Harold  Glenn 
Moulton. 

THE  VALUE  OF  ORGANIZED  SPECULATION.  By  Harri- 
son H.  Brace. 

INDUSTRIAL  EDUCATION:  ITS  PROBLEMS,  METHODS 
AND  DANGERS.     By  Albert  H.  Leake. 

THE  UNITED  STATES  INTERNAL  TAX  HISTORY  FROM 
I  86 1  TO  I  87  I .     By  Harry  Edwin  Smith. 

WELFARE  AS  AN  ECONOMIC  QUANTITY.  By  G.  P.  Wat- 
kins. 

CONCILIATION  AND  ARBITRATION  IN  THE  COAL  IN- 
DUSTRY IN  THE  UNITED  STATES.  By  Arthur  E.  Suf- 
fern. 

THE  CANADIAN  IRON  AND  STEEL  INDUSTRY.  By  W.  J. 
A.  Donald. 

THE  TIN  PLATE  INDUSTRY.     By  D.  E.  Dunbar. 

THE  MEANS  AND  METHODS  OF  AGRICULTURAL  EDU- 
CATION.    By  Albert  H.  Leake. 

THE  TAXATION  OF  LAND  VALUE.     By  Yetta  Scheftel. 

RAILROAD  VALUATION.     By  Homer  Bews  Vanderblue. 

RAILWAY  RATES  AND  THE  CANADIAN  RAILWAY  COM- 
MISSION.    By  D.  A.  MacGibbon. 

THE  CHICAGO  PRODUCE  MARKET.  By  Edwin  Griswold 
Nourse. 

THE  ARBITRAL  DETERMINATION  OF  RAILWAY  WAGES. 
By  J.  Noble  Stockett. 

THE  RESULTS  OF  MUNICIPAL  ELECTRIC  LIGHTING 
IN    MASSACHUSETTS.     By  Ldmond  Earle  Lincoln. 

FAIR  VALUE.  The  Meaning  and  Application  of  the  Term 
"Fair  Valuation"  as  used  by  Utility  Commissions.  By 
Harleigh  H.  Hartman. 

A  HISTORY  OF  THE  ATLANTIC  COAST  LINE  RAIL- 
ROAD.    By  Harold  Douglas  Dozier. 


%<xd>  (itfaflMt  &  (Wat*  $xty  <&88ty8 


xxvin 

FAIR  VALUE 

THE  MEANING  AND  APPLICATION  OF  THE  TERM 

"FAIR  VALUATION  "  AS  USED  BY  t 

UTILITY  COMMISSIONS 


FAIR  VALUE 

THE  MEANING  AND  APPLICATION  OF 

THE  TERM  "FAIR  VALUATION"  AS  USED 

BY  UTILITY  COMMISSIONS 


BY 

HARLEIGH  H.  HARTMAN,  MA.,  LL.M. 

LECTURER  IN  ILLINOIS  PUBLIC  UTILITIES  LAW  AT  NORTHWESTERN 

UNIVERSITY  SCHOOL  OF  LAW,  SOMETIME  INSTRUCTOR 

IN  ECONOMICS  AT  LAKE  FOREST  COLLEGE 


BOSTON  AND  NEW  YORK 
HOUGHTON  MIFFLIN  COMPANY 

(£be  fiitocrsiiDc  prcjffa  <gambrtDge 

1920 


COPYRIGHT,   I92O,  BY  HART,  SCHAFFNER  &    MARX 
ALL  RIO  UTS  RESERVED 


TO 
JOHN  H.  WIGMORE 

DEAN  OF  NORTHWESTERN  UNIVERSITY  SCHOOL  OF  LAW 


PREFACE 

This  series  of  books  owes  its  existence  to  the  generosity  of 
Messrs.  Hart,  Schaffner  &  Marx,  of  Chicago,  who  have 
shown  a  special  interest  in  trying  to  draw  the  attention  of 
American  youth  to  the  study  of  economic  and  commercial 
subjects.  For  this  purpose  they  have  delegated  to  the  under- 
signed committee  the  task  of  selecting  or  approving  of 
topics,  making  announcements,  and  awarding  prizes  an- 
nually for  those  who  wish  to  compete. 

For  the  year  ending  June  1,  1918,  there  were  offered: 

In  Class  A,  which  included  any  American  without  re- 
striction, a  first  prize  of  $1000,  and  a  second  prize  of  $500. 

In  Class  B,  which  included  any  who  were  at  the  time 
undergraduates  of  an  American  college,  a  first  prize  of  $300, 
and  a  second  prize  of  $200. 

Any  essay  submitted  in  Class  B,  if  deemed  of  sufficient 
merit,  could  receive  a  prize  in  Class  A. 

The  present  volume,  submitted  in  Class  A,  was  awarded 

first  prize  in  that  class. 

J.  Laurence  Laughlin,  Chairman 
University  of  Chicago 

J.  B.  Clark 

Columbia  University 

Henry  C.  Adams 

University  of  Michigan 

Edwin  F.  Gay 

N.  Y.  Evening  Post 
Theodore  E.  Burton 

New  York  City 


NOTE 

The  author  gratefully  acknowledges  his  indebtedness  to 
Professor  J.  M.  Clark,  of  the  University  of  Chicago,  for 
kind  assistance,  careful  criticism,  and  helpful  suggestions 
given  in  the  final  preparation  of  this  thesis.  Much  credit  is 
also  due  the  author's  wife  for  her  constant  encouragement 
and  cooperation.  For  all  matters  of  opinion,  however,  and 
for  the  manner  of  presentation  the  author  assumes  com- 
plete responsibility. 

Harleigh  H.  Hartman 

Springfield,  III. 
April,  1919 


AUTHOR'S  PREFACE 

The  term  "fair  value"  is  a  scapegoat  of  the  cost  theory 
coined  by  the  courts  and  adopted  by  public-utility  com- 
missions. The  scope  of  the  term  is  broad,  its  usage  loose. 
It  has  been  employed  in  many  phases  of  regulation  includ- 
ing rate-making,  purchase  and  sale,  security  issue,  reorgan- 
ization, tax  and  government-ownership  cases.  The  "fair 
value"  of  the  property  has  varied  for  each  of  these  pur- 
poses. The  result  has  been  confusion,  misunderstanding, 
and  misuse  of  the  term  and  much  superficial  wrangling. 
There  is  no  real  agreement  concerning  the  most  funda- 
mental principles  of  valuation.  There  is  confusion  as  to 
terminology,  methods,  even  as  to  the  objects  sought. 

The  causes  of  this  chaos  are  easily  discernible.  Two  par- 
ties, the  public  and  the  utilities,  are  vitally  concerned. 
Both  are  convinced  that  their  interests  are  inherently 
antagonistic.  The  courts  stand  arbitrator  between  them. 
New  issues  are  presented  at  a  time  when  the  whole  political, 
economic,  and  legal  concept  of  the  relation  of  government 
to  industry  and  private  property  is  in  a  transitional  state. 
The  issue  has  augmented  the  existing  conflict  between  judi- 
cial and  legislative  functions  resulting  from  new  applica- 
tions of  the  due-process  clause.  The  sphere  of  judicial  activ- 
ity at  the  start  of  the  valuation  problem  was  itself  unsettled. 
No  precedents  exist  to  guide  the  court  in  its  arbitration. 
Blind  groping  has  resulted.  The  parties  have  been  unwill- 
ing to  study  the  situation  more  than  superficially.  The 
utilities  and  over-zealous  public  representatives  have 
framed  their  words  and  acts  to  create  opportunities  for 
self-gain,  irrespective  of  the  ultimate  effects  of  their  poli- 
cies. The  courts  seem  to  have  followed  the  course  of  least 
resistance. 

Credit  for  such  progress  as  has  been  made  is  due  to 


sdi  AUTHOR'S  PREFACE 

the  State  Public-Utility  Commissions.  Their  efforts,  how- 
ever, have  been  handicapped  by  the  necessity  of  trying  to 
prophesy,  and  shape  their  opinions  to  meet,  the  undefined 
course  of  judicial  review  which  persistently  refuses  to  state 
either  the  basis  upon  which  it  rests  or  the  aims  it  seeks. 

There  is  little  reason  to  expect  either  the  utilities  or 
public  representatives  to  forget  self-interest,  voluntarily 
analyze  the  problem,  and  submit  an  unbiased  compromise. 
The  commissions  are  powerless  wholly  to  clear  the  confu- 
sion superimposed  upon  the  situation  by  judicial  review. 
The  courts  can  clear  the  tangle,  but  before  this  is  possible 
they  themselves  must  glean  a  much  clearer  understanding 
of  the  theory  of  "  fair  value  "  than  they  have  thus  far  incor- 
porated in  their  decisions.  They  must  accept  the  task  of 
determining  the  basis  and  aims  of  regulation,  and  definitely, 
unambiguously  state  them. 

The  study  of  valuation,  in  the  meantime,  must  be  essen- 
tially theoretical.  It  cannot  be  worked  out  from  existing 
decisions  alone  since  they  themselves  are  to  be  tested  by  it. 
Neither  can  it  be  worked  out  independently  of  them  and 
test  them.  A  twofold  division  of  the  subject  is  suggested, 
i.e.,  the  theory  of  "  fair  value  "  and  the  application  of  the 
theory  to  the  existing  situation.  This  division  has  been 
adopted  by  the  author. 

The  first  part  of  the  treatise  considers  (1)  the  problem 
of  public-utility  regulation  and  the  characteristics  which 
distinguish  it  from  that  of  regulation  in  general;  (2)  the 
specific  needs  it  suggests,  and  the  essential  elements  in  a 
regulatory  system  which  will  meet  those  needs;  (3)  the 
development  of  the  valuation  theory;  (4)  valuation  as  an 
element  in  regulation,  its  compatibility  with  existing  legal 
concepts,  its  advantages  and  dangerous  characteristics; 
(5)  "  fair  value,"  the  type  of  valuation  best  suited  to  public- 
service  regulation  and  to  existing  legal  rules. 

The  second  part  of  the  thesis  applies  the  general  princi- 
ples formulated  in  the  first  part  to  the  actual  practice  in 


AUTHOR'S  PREFACE  xiii 

commission-valuation  cases.  To  render  the  results  of  this 
study  more  readily  accessible,  this  part  of  the  subject  has 
been  divided  in  the  manner  common  to  prior  works  on 
valuation.  The  leading  valuation  cases  of  the  several  com- 
missions are  analyzed,  and  the  rules  applied  in  the  principal 
jurisdictions  formulated.  These  rules  are  subject  to  test  as 
to  their  economic  soundness  and  their  conformity  to  legal 
requirements.  Where  a  discrepancy  appears  between  com- 
mission rule  and  economic  law  or  legal  requirement,  it  is 
carefully  considered  and  the  author's  conception  of  the 
expedient  means  of  removing  the  discord  stated. 

The  thesis  attempts  to  state  the  theory  of  fair  value,  the 
law,  and  the  practice. 


CONTENTS 
PART  I 

THE  MEANING  OF  THE  TERM  "  FAIR  VALUE  " 

CHAPTER  I 

The  Basis  of  Regulation 

I.  Introductory  Statement  3 

II.  Private  Property  3 

III.  Limitations  upon  the  Use  of  Private  Prop- 

erty 5 

IV.  The  Laissez-Faire  Doctrine  6 
V.  Price  Economics  7 

VI.  The  Granger  Reaction  8 
VII.  Munn  v.  Illinois  9 
VIII.  Monopoly  as  a  Basis  for  Regulation  11 
IX.  The  Public-Interest  Theory  15 
X.  Judicial   Recognition   of  the  Public   In- 
terest, 20 
XI.  Summary  25 

CHAPTER  n 

The  Purpose  of  Regulation 

I.  Regulation  and  Private  Interest  27 

II.  Service  Requirements  28 

III.  Rate  Regulation  29 

IV.  The  Social  Side  of  Regulation  29 
V.  Northern     Pacific    Railway    v.  North 

Dakota  31 

VI.  Anti-Monopoly  Regulation  33 

VII.  The  Recognition  of  Regulated  Monopoly     34 


xvi  CONTENTS 

VIII.  The  Reasons  fob  the  Change  36 

IX.  Speculation  39 

X.  Efficient  Management  41 

XI.  Financial  Regulation  42 

XII.  Accounting  43 

XIII.  Summary  44 


CHAPTER  HI 

Valuation  and  Regulation 

I.  Valuation  a  Judicial  Theory  45 

II.  The  Granger  Cases  45 

III.  The  Commission  Cases  48 

IV.  Dow  v.  Beidelman  51 
V.  Reagan  v.  The  Farmers'  Loan  and  Trust 

Company  55 
VI.  The  Growth  of  the  Confiscation  Analogy    57 
VII.  Smyth  v.  Ames  59 
VLIL  The  Condemnation  Theory  63 
IX.  San  Diego  Land  and  Town  Company  v.  Na- 
tional City  71 
X.  Valuation  as  a  Test  for  Individual  Rates     73 
XL  The  Recent  Decisions  73 
XII.  Summary  74 

CHAPTER  IV 

The  Theory  of  Valuation 

I.  Valuation  and  Economics  77 

II.  The  Meaning  of  Value  77 

III.  The  Varying  Uses  of  Valuation  79 

IV.  Fair  Value  not  Exchange  Value  80 
V.  Valuation  for  Rate-Making  81 

VI.  Valuation  for  Purchase  and  Sale  88 

VII.  The  Methods  of  Valuation  90 

VIII.  Summary  92 


CONTENTS  xvii 

CHAPTER  V 

Valuation  Methods 

I.  The  Inventory  94 

II.  The  Original-Cost  Theory  97 

III.  The  Reproduction-Cost  Theory  99 

IV.  Development  of  the  Reproduction  Theory  100 
V.  The   Purpose   of  the   Reproduction-Cost 

Appraisal  105 

VI.  Attempt  to  Discredit  Original  Cost  107 

VII.  Defects  of  Strained  Reproduction  Cost       112 

VIII.  The  Actual-Investment  Theory  113 

IX.  The  Supreme  Court  and  Reproduction  Cost  119 

X.  Summary  124 


PART  II 

THE  APPLICATION  OF  THE  THEORY  OF  FAIR  VALUE 

CHAPTER  VI 

The  Valuation  of  Tangible  Property 

I.  Tangible  and  Intangible  Values  129 

II.  Property  not  Used  or  Useful  129 

III.  Property  acquired  without  Cost  133 

IV.  Property  acquired  from  Surplus  134 
V.  The  Valuation  of  Land  138 

VI.  The  Original-Cost  Appraisal  140 

VII.  Appreciation  of  Land  Values  141 

VEIL  The  Reproduction-Cost  Appraisal  146 

IX.  Valuation  of  Buildings  151 

X.  Water  Rights  153 

XL  Pavement  over  Mains  157 

XII.  Summary  159 


xviii  CONTENTS 

CHAPTER  VII 

Valuation  of  Intangible  Property 

I.  Overhead  Charges  161 

II.  Organization  Expenses  166 

III.  Promoters'  Profits  167 

IV.  Interest  during  Construction  167 
V.  Engineering  and  Superintendence  170 

VI.  Contractors'  Profits  172 

VII.  Discount  on  Bonds  173 

VIII.  Piecemeal  Construction  175 

IX.  Adaptation  and  Solidification  176 

X.  Going  Value  177 

XI.  Going-Concern  Value  180 

XII.  Going  Value  and  Exchange  Differential  181 

XIII.  "Good- Will"  182 

XIV.  The  Wisconsin  Rule  184 
XV.  The  Comparative-Plant  Estimate  of  Go- 
ing Value  186 

XVI.  Going  Value  and  the  Courts  188 

XVII.  Franchise  Value  190 

XVIII.  Working  Capital  193 

\  XIX.  Summary  194 

CHAPTER  VIII 

Depreciation 

I.  The  Theory  of  Depreciation  196 

II.  Efficiency  and  Depreciation  198 

III.  Judicial  Holdings  on  Depreciation  202 

IV.  Salvage  Value  204 
V.  Depreciation  of  Intangibles  205 

VI.  Estimated  Life  206 

VII.  The  Maintenance  Plan  and  Appraisal        207 

VIII.  The  Straight-Line  Method  207 

IX.  The  Diminishing-Balance  Method  209 


CONTENTS 


xix 


X.  The  Annuity  Method  210 

XI.  The  Sinking-Fund  Method  211 

XII.  Miscellaneous  Methods  212 

XIII.  The  Colorado  Theory  of  Depreciation  213 

XIV.  The  Depreciation  Reserve  216 
XV.  Summary  218 

CHAPTER  IX 

The  Return  on  the  Investment 

I.  Valuation  and  the  Rate  of  Return  220 
II.  The  Development  of  the   Return  Ques- 
tion 221 

III.  Elements  Involved  in  the  Return  222 

IV.  The  Interest  Element  in  the  Return  224 
V.  The  Risk  Element  in  the  Return  225 

VI.  The  Rate  of  Return  227 

VII.  Duplication  in  Valuation  and  Return  229 

VIII.  Reward  for  Efficient  Management  229 

IX.  Allowance  for  Surplus  231 

X.  Summary  231 

CHAPTER  X 

Conclusion  233 

Selected  Bibliography  237 

Table  of  Cases  241 

Index  253 


FAIR  VALUE 

PART  I 
THE  MEANING  OF  THE  TERM  "FAIR  VALUE" 


FAIR  VALUE 

CHAPTER  I 

'    THE  BASIS  OF  REGULATION 

I.  Introductory  Statement 

The  primary  question  in  regulation  is  the  legal  and  eco- 
nomic status  of  private  property.  To  discuss  valuation 
without  considering  the  nature  of  public-utility  property, 
the  reasons  for  its  control,  and  the  aims  of  regulation  would 
be  to  argue  the  expediency  of  means  without  knowing  the 
ends  sought.  This  fallacy  has  characterized  most  discus- 
sion of  valuation.  There  has  been  no  attempt  to  decide  fun- 
damental issues.  It  seems  advisable,  therefore,  even  at  the 
risk  of  criticism  for  using  primer  methods  and  covering 
ground  already  trodden,  to  begin  with  a  consideration  of 
the  status  of  "private  property  devoted  to  a  public  use." 

II.  Private  Property 

The  term  "private  property"  is  a  misnomer.  There  is  no 
strictly  private  interest  in  property  enjoyed  to  the  com- 
plete exclusion  of  all  other  interests.  This  point  cannot  be 
too  strongly  emphasized,  for  therein  lies  the  basis  of  all 
regulation  affecting  property  rights. 

Property  has  been  defined  as  "the  right  and  interest 
which  a  man  has  in  lands  and  chattels  to  the  exclusion  of 
others."  The  word  "right"  is  used  collectively.  Man  has 
many  rights  relative  to  the  object  he  is  said  to  own,  which 
combined  constitute  his  property  in  the  object;  i.e.,  the 
right  of  possession,  the  restricted  rights  of  consumption, 
use,  and  disposal  by  sale,  gift,  loan,  or  rental.  Property  is 
a  bundle  of  rights,  the  units  of  which  are  constantly  chang- 
ing with  economic  changes  and  their  legal  recognition. 


4  FAIR  VALUE 

Property  as  distinct  from  possession  implies  exclusive 
control.  Such  control  can  exist  only  by  consent  of  the  State. 
The  sanction  of  society  and  force  of  government  are  neces- 
sary to  protect  the  owner's  interest.  The  presence  of  an  or- 
ganized social  state  is  essential  to  the  existence  of  private 
property.  It  is  purely  a  social  concept,  and  the  rights  con- 
stituting property  at  any  given  time  depend  upon  social 
arrangements  sanctioned  by  the  State  with  a  view  to  the 
general  welfare. 

Private  property,  irrespective  of  the  theory  of  its  origin, 
is  shaped  by  two  conflicting  forces  giving  it  both  a  social 
and  an  individual  side.  Individuals  are  permitted  to  acquire 
rights  protected  by  the  State,  because  such  permission  pro- 
motes the  public  welfare.  The  private  interest,  however,  is 
held  in  subordination  by  the  State  police  power,  in  order 
that  the  exclusive  control  thus  created  may  in  reality  pro- 
mote the  common  good.  The  social  interest  on  which  the 
whole  structure  rests  limits  the  owner  in  his  use  of  the  prop- 
erty. All  property  is  acquired  and  held  under  the  limitation 
of  the  common-law  maxim,  "  Sic  utere  tuo  ut  alienum  nort 
Icedas,"  that  it  shall  not  be  used  in  a  way  injurious  to  the 
rights  of  others  nor  to  impair  the  public  rights.  The  State 
does  not  create  unrestricted  private  property  rights  in  ob- 
jects which  affect  or  influence  the  public  welfare.  The  pub- 
lic interest  in  such  property  must  be  protected  or  the  excuse 
for  government  sanction  of  the  private  interest  destroyed. 
The  so-called  absolute  property  rights  are  but  privileges 
relative  to,  and  limited  by,  the  common  good.  The  individ- 
ual and  the  public  interest,  though  independent,  attach  to 
the  same  object  and  blend.  The  individual  is  so  related  to 
society  that  his  interest  is  one  with  that  of  the  group.  The 
social  interest  is  as  necessary  to  private  property  as  the  in- 
dividual interest,  and  individual  rights  can  be  protected 
only  by  development  of  the  public  interest.  The  individual 
right  is  a  right  to  use  private  property  in  the  interest  of  the 
community.  Regulation  compels  such  use  of  the  property. 


THE  BASIS  OF  REGULATION  5 

The  two  forces  moulding  private  property,  because  one 
limits  the  other,  are  antagonistic.  The  elements  which  make 
the  social  side  essential  necessitate  the  domination  of  the 
social  over  the  individual  element  in  the  conflicts  which  re- 
sult. The  tendency,  therefore,  is  toward  an  ever  greater 
public  element  in  private  property.  Each  new  conflict  ulti- 
mately results  in  additional  gain  for  the  social  side  of  the 
property.  Regulation  based  on  valuation  is  such  a  conflict. 

III.  Limitations  upon  the  Use  of  Private  Property 

All  private  property  is  held  conditionally.  The  owner 
must  so  use  it  as  not  to  injure  others.  It  is  apparent  that  the 
danger  of,  and  opportunity  for,  such  injury  must  vary  both 
in  form  and  degree  with  the  use  to  which  the  property  is 
put.  The  State  in  seeking  to  protect  the  public  interest 
must  impose  different  forms  of  regulation  upon  the  differ- 
ent uses  of  the  property.  The  bundle  of  rights  constituting 
property  changes  with  the  use,  becoming  more  or  less  en- 
cumbered, acquiring  or  losing  unit  rights  as  the  use  pro- 
motes or  endangers  the  public  welfare.  Property  used  in 
connection  with  slaughter-houses,  pest-houses,  and  manu- 
facture of  explosives  is  subjected  to  stringent  regulation  to 
promote  the  public  health.  The  same  property  used  for  sa- 
loon or  questionable  lodging-house  purposes  would  be  sub- 
jected to  other  forms  of  regulation  with  a  view  to  promo- 
tion of  the  public  morals.  This  property  used  for  strictly 
residence  purposes  would  meet  with  but  little  governmen- 
tal interference.  Devoted  to  a  public  use  and  employed  in 
the  conduct  of  a  public-service  business,  the  property  is 
subjected  to  regulation  drafted  primarily  to  promote  the 
economic  welfare  of  the  public. 

Public-service  corporations  have  always  been  classified 
separately  in  American  law.  Private  property  employed  in 
the  public  service  has  always  been  subject  to  restrictions  in 
the  interest  of  the  public.  The  social  side  of  the  property 
has  always  been  more  prominent  than  the  strictly  private 


6  '    FAIR  VALUE 

interests.  The  emphasis  on  the  public  interest  in  such  prop- 
erty and  the  accompanying  distinction  between  utilities 
and  other  industry  is  based  on  the  common  law  and  ante- 
dates the  establishment  of  the  colonies. 

IV.   The  Laissez-Faire  Doctrine 

The  regulation  and  restriction  imposed  by  the  Govern- 
ment on  private  property  devoted  to  a  public  use  in  addi- 
tion to  that  imposed  on  all  private  property,  and  conse- 
quently the  bundle  of  rights  composing  private  property 
in  such  a  use,  undergo  constant  change.  The  political, 
social,  and  economic  order  is  slowly  but  continually  shift- 
ing. The  private  rights  and  the  public  interest  increase 
or  decrease  to  meet  economic  and  social  conditions.  From 
the  middle  of  the  eighteenth  century  to  1870  private  in- 
terests predominated.  Economic  conditions  in  America 
throughout  the  colonial  period  and  the  early  days  of  the 
Republic  did  not  justify  emphasis  on.  the  difference  be- 
tween property  employed  in  the  public  service  and  that  de- 
voted to  a  strictly  private  use.  The  differentiation  and  the 
corollary  power  of  regulation,  therefore,  remained  dor- 
mant, and  a  strict  laissez-faire  policy  was  adopted. 

A  vast,  thinly  populated  territory  lay  open  to  develop- 
ment. Governments  were  new  and  overburdened.  Heavy 
taxes  could  not  be  collected.  Innumerable  local  improve- 
ments were  needed.  The  very  vastness  of  the  land,  which 
rendered  transport  and  communication  facilities  necessary, 
made  them  more  difficult  to  secure.  Private  capital  was  the 
only  means  available  for  the  work.  Every  effort  was  made 
to  encourage  its  investment  in  enterprises  which  would 
develop  the  land. 

The  territory  to  be  served  was  too  broad,  the  capital  re- 
quired too  great,  the  demand  for  other  improvements  too 
pressing  to  justify  viewing  the  encroachment  of  individual 
initiative  with  feeling  other  than  relief.  The  situation  was 
not  complex.  The  corporation  was  in  its  infancy.  The  terri- 


THE  BASIS  OF  REGULATION  7 

tory  served  by,  and  the  capital  invested  in,  each  utility  was 
small.  Competition  between  utilities  and  with  substitute 
service  was  abundant,  and  the  prevailing  public  opinion  re- 
garded competition  as  a  panacea  for  all  industrial  ills.  There 
was  little  to  fear,  much  to  be  gained,  from  stimulation  of 
private  enterprise. 

The  legislatures  responded  to  the  demands  of  the  time  by 
giving  private  enterprise  an  entirely  free  hand,  and  ex- 
tending active  aid  to  those  who  could  be  induced  to  under- 
take the  work.  The  power  of  eminent  domain  was  granted 
and  liberally  construed.  Public  lands  were  freely  given. 
Public  funds  were  invested  in  the  securities  of  the  compa- 
nies or  given  to  the  promoters  outright.  Charters  and  fran- 
chises were  lavishly  bestowed  and  prodigally  drafted.  Every 
effort  was  put  forth  to  make  the  undertaking  an  invit- 
ing speculation.  The  public  nature  of  the  enterprises  was 
widely  advertised,  and  persons  investing  in  them  were  her- 
alded as  public  benefactors. 

The  policy  was  not  restricted  to  public-service  companies. 
All  industry  flourished  under  the  laissez-faire  system.  Indi- 
vidualism was  supreme.  Private  interests  were  emphasized, 
and  private  property  enjoyed  a  legal  status  theretofore  and 
since  unknown. 

V.  Price  Economics 

The  result  of  the  laissez-faire  policy  was  a  reorganiza- 
tion of  economic  theory  upon  an  emphasized  private-prop- 
erty basis.  Pursuit  of  individual  gain  and  production  for 
exchange  became  the  dominant  factors  in  industry.  An 
exchange  economics  was  worked  out,  centering  on  price, 
the  medium  of  exchange.  Price  became  the  all  important 
factor  in  industry.  The  theory  of  price  underlies  all  eco- 
nomic theory  of  the  period. 

The  economic  system  which  emphasized  individual  gain 
and  exchange  price  was  bound  to  produce  undesirable  re- 
sults when  applied  to  the  public  service.  The  public  interest 


8  FAIR  VALUE 

in  the  undertaking  received  no  consideration  in  such  an 
economic  system.  The  social  side  of  private  property  was 
subordinated  to  the  individual  side  and  lost  sight  of.  The 
public  interest  in  the  service  was  secondary  to  private 
gain.  Reasonable  rates  were  replaced  by  market  price. 
The  basis  of  private  property,  the  excuse  for  its  creation 
and  maintenance,  was  overlooked. 

VI.   The  Granger  Reaction 

It  was  inevitable  that  application  of  price  economics  to 
the  public  service,  the  mania  for  development  and  the  ac- 
companying opportunities  for  enrichment  of  private,  at  the 
expense  of  public,  interests  afforded  by  the  laissez-faire 
policy  should  produce  wholesale  evils.  Shippers  demanded 
and  received  rebates.  Discriminations  were  granted  and 
accepted.  Utility  operators,  promoters,  investors,  and  con- 
sumers vied  to  squeeze  the  opportunity  dry. 

It  was  equally  inevitable  that  the  abuses  of  the  period 
should  produce  a  reaction.  Changed  economic  conditions, 
the  growth  of  the  factory  system,  the  congestion  of  popula- 
tion in  urban  districts,  and  the  increase  of  wealth  rendered 
a  continuation  of  the  laissez-faire  policy  dangerous.  Strin- 
gent legislation  became  necessary  to  make  property  rights 
serve  the  purpose  for  which  they  were  created,  the  promo- 
tion of  the  public  welfare;  to  offset  the  undue  emphasis  of 
the  private  side  of  property  by  the  laissez-faire  policy;  and 
to  substitute  an  economics  based  on  public  interests  and 
reasonable  charges  rather  than  private  gain  and  prices 
fixed  by  individualistic  enterprise  and  free  bargain. 

The  revolt  started  in  the  West  as  a  clamor  for  a  renewal 
of  governmental  control,  a  reassertion  of  the  public  interest, 
and  a  reaffirmation  of  the  purpose  of  property  rights.  The 
acute  need  of  development  and  the  absolute  dependence 
upon  the  utilities  for  connection  with  markets  and  in- 
dustrial centers,  had  made  that  section  the  harvest  field  of 
unscrupulous  promoters  and  had  forced  utility  problems  to 


THE  BASIS  OF  REGULATION  9 

the  front.  The  five  years  preceding  1870  produced  a  com- 
plete change  in  public  opinion.  Indignation  was  aroused. 
The  Patrons  of  Husbandry,  or  Grange,  served  as  a  medium 
to  spread  the  discontent;  and  it  rapidly  developed,  under 
railway  defiance  of  public  interests,  into  rabid  prejudice. 

The  rate  issue  was  the  most  vital.  The  laissez-faire  policy 
had  resulted  in  the  establishment  of  monopoly  prices 
at  all  non-competitive  points  and  discriminatory  charges 
based  on  a  competitive  exchange  price  elsewhere.  Reason- 
able rates  were  unknown.  To  correct  the  situation  a  wave  of 
maximum-rate  legislation  swept  the  Middle  West.  The  util- 
ities, championed  by  the  railways,  contested  the  constitu- 
tionality of  the  laws.  The  issue  was  the  sacredness  of  the 
private-property  interests  which  the  laissez-faire  policy  had 
emphasized  without  due  regard  to  the  purpose  of  property 
rights.  The  question  was  carried  to  the  Federal  Supreme 
Court  and  the  State's  right  to  regulate,  to  confine  property 
rights  to  their  proper  sphere,  was  upheld  in  the  Granger 
Cases.1  A  movement  was  thus  inaugurated  which  has  rev- 
olutionized the  relation  of  government  to  industry. 

VII.  Munn  v.  Illinois 

In  Munn  v.  Illinois,2  the  principal  Granger  Case,  the 
latent  power  of  regulation  was  revivified.  The  public  utility 
was  again  singled  out  from  other  industries  and  subjected 
to  regulation.  The  case  came  before  the  Court  on  the  ques- 
tion of  the  constitutionality  of  an  Illinois  law  fixing  the 
charges  for  warehouses.  The  prime  problem  was  to  justify 
the  segregation  of  warehouses  from  other  industries  for 

1  There  were  eight  Granger  cases  arising  from  the  maximum  rate  laws 
of  the  Mid- Western  States.  All  save  the  Munn  Case  involved  railway  regu- 
lation. They  were:  Munn  v.  Illinois,  94  U.S.  113,  24  L.  ed.  72;  Chicago,  Bur- 
lington &  Quincy  R.R.Co.  v.  Iowa,  94  U.S.155, 24  L.  ed.  94;  Peik  v.  Chicago 
&  Northwestern  Ry.  Co.,  94  U.S.  164;  Chicago,  Milwaukee  &  St.  Paul 
Ry.  Co.  v.  Ackley,  94  U.S.  179;  Winona  and  St.  Peter  R.R.  Co.  v.  Blake, 
94  U.S.  180, 45  L.  ed.  99;  Southern  Minnesota  R.R.  Co.  v.  Coleman,  94  U.S. 
181;  Stone  v.  Wisconsin,  94  U.S.  181, 24  L.  ed.  102. 

8  94  U.S.  115,  24  L.  ed.  72. 


10  FAIR  VALUE 

regulatory  purposes.  The  propriety  of  applying  the  laissez- 
faire  policy  to  other  industry  was  not  questioned.  The  fact 
that  the  sanctity  of  the  emphasized  private  rights  in  prop- 
erty in  general  was  still  unchallenged  rendered  the  prob- 
lem difficult.  The  way,  however,  had  been  paved  for  the 
decision  by  the  Supreme  Court's  holding  in  the  case  of 
Olcott  v.  The  Supervisors,1  that  irrespective  of  the  private 
ownership  of  the  property  a  railroad  is  a  public  highway 
performing  a  governmental  function  for  which  it  is  paid  by 
being  granted  the  right  to  exact  reasonable  tolls. 

The  Munn  decision  accepts  the  theory  of  the  Olcott 
Case.2  The  private  property  of  the  utility  operator  is  em- 

1  16  Wall.  695;  83  U.S.  678.  "It  has  never  been  considered  a  matter  of 
any  importance  that  the  road  was  built  by  the  agency  of  a  private  corpora- 
tion. No  matter  who  is  the  agent,  the  function  performed  is  that  of  the  State. 
Though  the  ownership  is  private,  the  use  is  public.  .  .  .  That  railroads, 
though  conducted  by  private  corporations  and  owned  by  them,  are  public 
highways  has  been  the  doctrine  of  nearly  all  the  courts  ever  since  such  con- 
veniences for  passage  and  transportation  have  had  any  existence.  .  .  .  And 
the  reason  why  the  use  has  always  been  held  a  public  one  is  that  such  a 
road  is  a  highway,  whether  made  by  the  Government  itself  or  by  the 
agency  of  corporate  bodies,  or  even  by  individuals  when  they  obtain  their 
power  to  construct  it  from  legislative  grant. 

"So  turnpikes,  bridges,  ferries,  and  canals,  although  made  by  individu- 
als under  public  grants,  or  by  companies,  are  regarded  as  publici  juris. 
The  right  to  exact  tolls  or  charge  freight  is  granted  for  a  service  to  the 
public.  .  .  . 

"  They  [highways]  have  always  been  governmental  affairs  and  it  has  ever 
been  recognized  as  one  of  the  most  important  duties  of  the  State  to  provide  and 
care  for  them.  ...  It  is  said  that  railroads  are  not  public  highways  per  se: 
That  they  are  only  declared  such  by  the  decisions  of  the  courts,  and  that 
they  have  been  declared  public  only  with  respect  to  the  power  of  eminent 
domain.  This  is  a  mistake.  In  their  very  nature  they  are  public  highways.  It 
needed  no  decision  of  courts  to  make  them  such.  True  they  must  be  used 
in  a  peculiar  manner,  and  under  certain  restrictions,  but  they  are  facilities 
for  passage  and  transportation  afforded  to  the  public,  of  which  the  public 
has  a  right  to  avail  itself.  As  well  might  it  be  said  a  turnpike  is  a  highway, 
only  because  declared  such  by  judicial  decision.  A  railroad  built  by  the 
State  no  one  claims  would  be  anything  else  than  a  public  highway,  justi- 
fying taxation  for  its  construction  and  maintenance,  though  it  could  be  no 
more  open  to  public  use  than  is  a  road  built  and  owned  by  a  corporation." 

2  "Looking,  then,  to  the  common  law,  from  whence  came  the  right 
which  the  Constitution  protects,  we  find  that  when  private  property  is 


THE  BASIS  OF  REGULATION  11 

ployed  in  a  public  business  for  the  private  purpose  of  mak- 
ing individual  gain.  But  because  the  business  affects  the  wel- 
fare of  the  whole  community,  the  private  interest  in  profits 
is  subordinated  to  the  public  interest.  The  property  re- 
mains private  so  far  as  title  is  concerned,  but  loses  its  sta- 
tus as  strictly  private  property.  The  bundle  composing  pri- 
vate property  is  changed.  Some  of  the  unit  rights  are  lost. 
The  bundle  is  decidedly  smaller.  An  encumbrance  is  placed 
upon  the  property  as  real  as  that  created  by  dedication.  It 
must  be  used  subject  to  governmental  supervision,  and 
primarily  to  promote  the  public  welfare  by  rendering  con- 
tinuous, adequate  service  without  discrimination  and  at 
reasonable  rates.  The  charges,  representing  both  rental  or 
interest  and  pay  for  conducting  the  enterprise,  must  be 
such  as  will  promote  the  public  good.  The  property  has  been 
shorn  of  the  power  it  possessed,  under  the  laissez-faire 
theory,  of  producing  all  the  profit  unrestricted  conditions 
would  afford.  The  promotion  of  the  general  economic  wel- 
fare which  first  created  private  property  rights  and  then  or- 
dained that  they  be  given  free  sway  to  provide  incentive 
for  development,  now  demands  that  they  be  limited.  Abso- 
lute freedom  has  ceased  to  promote  the  common  good.  Reg- 
ulation becomes  necessary. 

VIII.   Monopoly  as  a  Basis  for  Regulation 

The  reference  to  monopolistic  power  and  citation  of 

Aldnut  v.  Inglis  2  in  the  Munn  Case  gave  rise  to  an  attempt 

affected  with  a  public  interest  it  ceases  to  be  juris  privati  only.  .  .  .  Pri- 
vate property  does  become  clothed  with  a  public  interest  when  used  in  a 
manner  to  make  it  of  public  consequence,  and  affect  the  community  at  large. 
When  therefore  one  devotes  his  property  to  a  use  in  which  the  public  has 
an  interest,  he,  in  effect,  grants  the  public  an  interest,  in  that  use,  and  must 
submit  to  be  controlled  by  the  public  for  the  common  good,  to  the  extent  of 
the  interest  he  has  thus  created.  He  may  withdraw  his  grant  by  discontin- 
uing the  use;  but  so  long  as  he  maintains  the  use,  he  must  submit  to  the 
control.  .  .  . 

"They  [the  warehouses]  stand,  to  use  the  language  of  their  counsel,  in 
the '  gateway  of  commerce, '  and  take  toll  from  all  who  pass.  Their  business 
most  certainly  tends  to  a  common  charge,  and  is  become  a  thing  of  com- 
mon interest  and  use."  2  12  East.  527. 


12  FAIR  VALUE 

to  base  regulation  upon  the  monopolistic  tendency  in  the 
public-service  business.  The  public  mind  has  been  directed 
from  the  public  nature  of  the  undertaking  toward  the  monop- 
olistic theory  of  regulation  and  the  sanctity  of  private 
property. 

Reference  to  monopoly  cannot,  unaided,  explain  public- 
utility  regulation.  Such  an  explanation  is  superficial  and 
goes  only  halfway  into  the  question.  It  does  not  explain 
why  the  State  may  regulate  a  monopolistic  business.  It 
fails  to  show  why  utility  regulation  differs  from  that  ap- 
plied to  banks,  insurance  companies,  and  other  monopolis- 
tic enterprises.  It  determines  neither  the  basis  nor  the  aims 
of  regulation.  The  monopolistic  theory  of  regulation  is  a 
survival  of  the  laissez-faire  economic  system.  It  is  a  com- 
promise not  in  accord  with  the  present  regulatory  theory, 
and  does  not  meet  the  issue  squarely. 

Monopolistic  power  in  any  business  has  been  recognized 
as  necessitating  governmental  regulation  since  the  early 
days  of  the  common  law.  Monopoly  was  especially  repug- 
nant to  the  judicial  and  economic  theories  based  upon  com- 
petition as  a  regulatory  force.  There  was  a  latent,  inherent 
power  of  harm  seen  in  monopoly.  Its  threat  prices  were 
feared,  and  monopolistic  practices  were  considered  as 
necessarily  contrary  to  the  public  welfare. 

It  is  doubtful,  however,  whether  the  common  law  sub- 
jected an  industry  to  rate  regulation  on  the  ground  of  mo- 
nopoly alone.  It  is  certain  that  it  did  not  conceive  of 
limitation  of  profits  as  distinct  from  prices,  nor  of  service, 
financial,  and  general  economic  regulation  as  a  corollary 
to  a  monopolistic  tendency.  Monopolies  were  regulated, 
but  always  upon  a  basis  wholly  distinct  from  that  justify- 
ing and  directing  public-service  company  control. 

Monopoly  may  justify  regulation.  It  may  emphasize  the 
public  nature  of  a  utility  business.  But  it,  unaided,  cannot 
create  a  public  calling  from  a  private  enterprise,  or  give  rise 
to  the  "public  interest"  of  the  Munn  Case. 


THE  BASIS  OF  REGULATION  13 

A  banking  or  insurance  company  may  enjoy  a  complete 
monopoly  while  a  neighboring  telephone  company  strug- 
gles with  a  vigorous  competitor,  yet  the  telephone  company 
is  a  public  utility  and  its  monopolistic  neighbors  retain 
their  private  status.  A  carrier  may  secure  complete  control 
of  the  most  remunerative  local  traffic  by  private  contract 
without  engaging  in  a  public-service  undertaking.  The 
completeness  of  his  control  over  the  industry  may  even 
force  out  of  business  competitors  who  had  undertaken  the 
public  service  without  altering  the  private  character  of  his 
business. 

Reference  to  monopoly  is  equally  ineffective  in  explaining 
the  aims  of  regulation.  An  order  prohibiting  the  invasion  of 
occupied  territory  or  permitting  a  consolidation  or  merger 
cannot  be  characterized  as  a  eulogy  of  competition  or  an 
elegy  for  monopoly.  In  rate-making  the  aim  is  the  true  nor- 
mal price,  which  because  of  the  waste  of  competition  is  in- 
variably below  the  competitive  figure.  The  whole  stress  of 
regulation  is  to  enforce  charges  not  to  the  competitive 
point,  i.e.,  cost  in  the  most  disadvantageously  located  and 
unskillfully  operated  plant  that  can  survive  during  any 
prolonged  period,  but  beyond  that  point  to  the  plane  of  the 
most  advantageously  located  and  skillfully  managed  plant 
that  the  locality  is  capable  of  supporting.  Regulation,  in 
the  case  of  public  utilities,  is  more  than  a  substitution  for 
competition.  It  must  enforce  the  economies  in  production 
that  competition  has  never  been  powerful  enough  to  com- 
pel. It  must  avoid  the  waste  of  duplication  and  it  must 
eliminate  the  uncertainty  and  speculation  of  competitive 
production.  It  substitutes  the  knowledge  and  judgment  of 
the  Government  for  that  of  a  competitor  potential  or  real. 
Its  aim  is  promotion  of  the  public  good  rather  than  promo- 
tion of  the  interest  of  an  individual  competitor.  It  is  moved 
by  forces  which  never  come  into  play  in  a  strictly  competi- 
tive industrial  organization. 

Monopoly,  for  the  most  part,  plays  the  same  role  in  the 


14  FAIR  VALUE 

public-service  field  that  it  does  elsewhere  in  industry.  Its 
economic  advantages  are  recognized,  its  evil  forces  held  in 
check.  Because  utilities  are  by  nature  best  operated  as  mo- 
nopolies, that  form  of  organization  is  sanctioned  for  them. 
Where  regulated  monopoly  fails  to  provide  adequate  serv- 
ice at  reasonable  rates,  however,  competition  is  called  upon 
for  aid.1 

The  different  part  which  monopoly  plays  in  the  utility 
and  industrial  field  is  rather  a  difference  in  the  aims  than  in 
the  basis  of  regulation.  Because  the  service  is  governmental, 
because  its  public  character 2  emphazises  the  undesirability 
of  duplication,  the  aim  of  utility  regulation  is  to  encourage 
monopoly.  In  the  general  industrial  field  where  the  public 
interest  is  not  so  intense,  where  the  uncertainties  of  com- 
petitive production  are  less  disastrous,  the  aim  of  regulation 
is  to  encourage  large-scale  production  but  upon  a  competi- 
tive, not  a  monopolistic,  basis.  Competition  is  not  harmful 
to  the  public  welfare  and  is  made  a  part  of  the  regulatory 
system  just  as  it  is  in  utility  control  when  other  regulation 
fails  because  a  company  is  unwilling  or  unable  to  render 
adequate  service.  The  point  is  that  the  public  welfare  de- 
mands a  different  form  of  regulation  in  the  case  of  utilities 
not  because  competition  is  impossible,  but  because  it  is  un- 
desirable. More  rigid  regulation  is  necessary  in  the  public 
service  than  elsewhere,  not  because  monopoly  is  more  dan- 
gerous or  more  apt  to  be  present,  but  because  the  undertak- 

1  Re  Coles  Co.  Tel.  &  Telg.  Co.,  111.  Pub.  Utilities  Comm.  No.  7280, 
7313;  Re  Northampton  Co.,  Water  Co.  (Pa.)  P.U.R.  1917-E-939;  Re 
Cayuga  Power  Corp.  (N.Y.)  P.U.R.  1917-E-915;  Re  Poy  Sippi  Tel.  Co. 
(Wis.)P.U.R.  1917-B-469;  Vogt  v.  Linden  Tel.  Co.  (Wis.)  P.U.R.  1917-A- 
614;  Allegheny  Valley  St.  R.R.  Co.  v.  Greco  (Pa.)  P.U.R.  1917-A-723,  etc. 

*  "Natural  monopoly"  when  analyzed  seldom  means  real  inability  to 
duplicate  service.  It  means  simply  that  the  common  weal  will  be  better 
served  by  a  single  system  than  by  duplication.  The  public  welfare  is  the 
basis  of  the  idea  of  natural  monopoly.  Few  utilities  are  strictly  monopolis- 
tic in  the  sense  that  duplication  or  competitive  substitute  service  is  really 
impossible.  Though  duplication  would  involve  a  real  disadvantage,  the 
advantages  of  location  are  scarcely  more  pronounced  in  the  utility  field 
than  elsewhere. 


THE  BASIS  OF  REGULATION  15 

ing  is  governmental,  because  the  service  must  be  guaran- 
teed, and  centralized  control  is  advantageous.  There  is  a 
socialistic  element  present  that  does  not  exist  in  the  regula- 
tion of  other  industries.1  The  industry  regulated  cannot  be 
left  to  the  uncertainties  of  competition.  Utility  commis- 
sions have  repeatedly  found  themselves  compelled  to  deny 
the  voluntary  petitions  of  utility  companies  for  permission 
to  discontinue  service.  Adequate,  continuous,  efficient 
service  must  be  enforced  at  a  price  low  enough  to  insure 
its  general  use.  The  public  has  an  interest  not  only  in  the 
service,  but  in  the  profit,  which  is  not  created  by  monopoly. 

IX.  The  Public-Interest  Theory 

The  attempt  to  base  the  decision  in  Munn  v.  Illinois  pri- 
marily upon  the  monopoly  theory  is  superficial,  misleading, 
and  unjustifiable.  That  case  and  its  cited  authority,  if  one 
will  pause  to  go  below  the  language  of  the  opinions,  clearly 
premises  the  regulation  of  public-service  companies  on  the 
public  nature  of  the  business  which,  because  the  welfare  of 
the  community  at  large  is  at  stake  and  the  State  is  forced 
practically  to  guarantee  the  service,  both  as  to  quality  and 
price,  assumes  the  character  of  a  governmental  function.2 

1  The  recent  abnormal  cost  of  producing  public-utility  service  has  em- 
phasized this  phase  of  the  question.  The  practical  impossibility  of  compel- 
ling prolonged  service  by  a  private  company  at  less  than  cost  forced  Mas- 
sachusetts to  revert  to  subsidies  and  spread  the  cost  of  street-railway 
service  by  general  taxation  in  an  effort  to  maintain  adequate  service  and 
keep  rates  at  a  point  which  would  permit  universal  use  of  the  service. 
Regulation  considered  the  general  need  and  the  governmental  character 
of  the  service  not  monopoly  prices. 

2  The  courts  have  repeatedly  pointed  out  the  governmental  character 
of  the  service  rendered.  "  A  railroad  once  constructed  is  instanter,  and  by  mere 
force  of  the  grant  and  law,  embodied  in  the  governmental  agencies  of  the  State 
and  dedicated  to  the  public  use,  all  and  singular  its  cars,  engines,  right  of 
way  and  property  of  every  description,  real,  personal,  and  mixed,  are  but  a 
trust  fund  for  the  political  power.  The  corporation  created  by  sovereign 
power  expressly  for  this  sole  purpose  and  no  other,  is  in  the  most  strict, 
technical,  and  unqualified  sense,  but  its  trustee.  This  is  the  primary  and 
sole  motive  for  its  creation.  The  incidental  interest  and  profit  of  individu- 
als are  accidents  both  in  theory  and  in  practice."   Talcott  v.  Pine  Grove, 


16  FAIR  VALUE 

The  construction  and  maintenance  of  transportation  agen- 
cies and  the  provision  of  adequate  water  and  lighting  sys- 
tems is  a  public  duty.  The  power  of  the  State  to  conduct  the 
service  is  unquestioned.  When  the  State  waives  its  right  to 
serve  and  an  individual  assumes  the  duty,  he  volunteers  to 
do  the  work  of  the  State.  The  basis  of  regulation  is  to  be 
found  in  the  governmental  nature  of  the  service. 

The  service,  because  it  is  a  common  necessity  and  the 
supply  is  so  limited  as  to  be  capable  of  control  by  a  few  per- 
sons, becomes  a  right  of  the  public  subject  only  to  certain 
general  conditions  applicable  to  all  alike.  Control  of  that 
right  is  "farmed  out,"  by  way  of  franchise  privileges,  to 
individuals.  The  Government  waives  its  right  to  conduct 
the  undertaking,  but  cannot  waive  its  responsibility  for 
the  service  rendered.  The  social  side  of  the  private  property 
devoted  to  the  public  use  necessarily  becomes  dominant. 
The  Munn  Case  and  subsequent  decisions  recognize  this 
fact.  The  monopoly  element  is  introduced  into  the  decisions 

1  Flipp.  (U.S.)  120;  "A  railroad  corporation  is  created  for  public  purposes 
and  -performs  a  function  of  the  State,  and  is  under  governmental  supervi- 
sion and  control,"  Culver  v.  St.  Joseph  &  G.  I.  Ry.  Co.  (Mo.)  P.U.R.  1917- 
B-542,  554;  "The  duties,  functions,  and  property  of  railroad  corporations 
are  held  in  trust  by  the  corporation  for  the  public,  and  the  sovereign  power 
regulates  such  corporations  as  its  trustee,"  People  v.  N.  Y.  C.  &  H.  R.R.  28 
Hun  (N.Y.)  543;  see  also  Smalley,  Railroad  Rate  Control,  pp.  13-21; 
"  The  creation  of  all  highways  is  a  public  duty.  Railroads  are  highways. 
The  State  may  build  them.  If  an  individual  does  the  work  he  is  pro  tanto  do- 
ing the  work  of  the  Stale.  He  devotes  his  property  to  a  public  use.  The 
State  doing  the  work  fixes  the  price  for  the  use.  It  does  not  lose  the  right 
to  fix  the  price  because  an  individual  voluntarily  undertakes  to  do  the 
work,"  Budd  v.  New  York,  143  U.S.  549,  12  Sup.  Ct.  468;  "A  railroad 
corporation  is  an  artificial  person,  created  by  positive  law,  and  invested 
with  franchises  involving  specific  powers  and  privileges,  conferring  some 
of  the  attributes  of  sovereignly,  to  be  exercised  primarily  for  the  benefits 
and  advantages  of  the  public,"  Bradley  v.  Ohio  River,  etc.,  R.R.  Co., 
78  Fed.  387;  Olcott  v.  The  Supervisors,  16  Wallace,  695,  83  U.S.  678; 
Munn  v.  Illinois,  94  U.S.  113,  24  L.  ed.  72.  See  also  Railroad  Commission 
v.  P.  &  O.  C.  R.  Co.,  63  Me.  269;  Banker  v.  L.I.  R.R.  Co.,  89  Hun  (N.Y.) 
202;  Beekman  v.  Saratoga,  etc.,  R.R.  Co.,  3  Paige,  45;  Bloodgood  v.  Mo- 
hawk and  Hudson  R.R.  Co.,  18  Wendell,  1 ;  Worcester  v.  R.R.  Co.,  4  Met- 
calf,  564. 


THE  BASIS  OF  REGULATION  17 

to  state  the  aims,  not  the  basis,  of  regulation.  Monopoly  in 
the  Munn  Case  merely  emphasized  and  pointed  out  the 
public  nature  of  the  business.1  Any  serious  threat  against 
the  availability  or  extent  of  any  essential  service,  whether 
by  way  of  competitive  strife  and  duplication,  excessive 
cost  of  production,  or  monopolistic  prices  and  limitation  of 
service  for  monopolistic  gain  is  sufficient  to  create  a  "public 
interest." 

The  public  nature  of  certain  industries,  re-enunciated  in 
the  Munn  and  Olcott  Cases,  has  been  recognized  from  the 
earliest  stages  of  governmental  development.  Usually  gov- 
ernment ownership  and  operation  have  preceded  the  dele- 
gation of  authority  to  private  individuals.  The  quasi- 
private  nature  of  the  public  business  has  developed  since 
private  wealth  has  been  accumulated  in  large  amounts 
and  public  needs  have  grown  faster  than  government  re- 
sources. 

Highways,  inns,  and  water-supplies  have  always  been 
government  industries.  The  Hindoos,  Babylonians,  Assyri- 
ans, Phoenicians,  Persians,  and  other  ancient  peoples  de- 
veloped extensive  highways,  lined  them  with  trees,  set 
mile-stones,  and  provided  inns,  resting-places  and  wells  for 
travelers.  The  antiquity  of  public  water  systems  is  testified 
to  by  the  great  aqueducts  of  Rome  and  the  ancient  public 
wells. 

A  thousand  years  ago  China  developed  a  network  of 
State  canals.  Three  centuries  before,  an  Egyptian  king 

1  An  attempt  has  been  made  by  some  writers  to  base  regulation  upon 
the  franchise  privilege,  the  grant  of  the  power  of  eminent  domain,  and 
State  aid.  These  privileges,  however,  like  regulation  itself,  are  but  a  result 
of  the  public  nature  of  the  business.  The  undertaking  is  not  public  because 
such  concessions  are  granted.  The  privileges  are  extended  and  regulation 
is  enforced  because  the  business  is  public.  Property  acquired  by  condem- 
nation proceedings  and  used  under  franchise  restrictions  in  a  privileged 
undertaking  is,  of  course,  subject  to  an  appreciable  encumbrance  which 
directly  affects  its  use  and  value.  The  fundamental  basis  of  this  encum- 
brance, however,  is  the  public  interest  which  justifies  both  the  use  of  emi- 
nent domain  and  the  franchise  grant. 


18  FAIR  VALUE 

constructed  the  Suez  Canal.  The  Royal  Canal  uniting  the 
Tigris  and  Euphrates  was  completed  about  600  b.c.  The 
Moors  built  artificial  government  waterways  in  Spain. 
Alexander  the  Great  covered  Egypt  with  a  network  of 
waterways,  and  Marius  and  Claudius  constructed  govern- 
ment canals  in  Rome.  The  public  character  of  artificial 
waterways  has  always  been  predominant. 

The  coming  of  the  turnpike  and  railway  did  not  alter  the 
nature  of  the  undertaking.  Improvements  in  the  highways 
only  served  to  emphasize  the  public  character  of  the  trans- 
portation service.  Many  more  of  the  State's  subjects  be- 
came directly  affected.  The  need  for  means  of  commu- 
nication became  greater.  The  utility  of  the  service  to  the 
Government  increased.  The  relation  of  the  transportation 
system  to  the  distribution  of  wealth,  to  all  industrial  ac- 
tivities, to  all  orderly  human  relations,  and  to  the  progress 
and  welfare  of  the  State  became  more  complex.  The  govern- 
mental character  of  the  service  became  more  apparent. 

The  telegraph,  telephone,  express,  bus-line,  and  pipe- 
line possess  the  same  characteristics  which  made  the  older 
means  of  transportation  public.  The  utilities  furnishing 
transport  and  other  communication  service  form  the  physi- 
cal basis  and  instrumentality  of  all  modern  political,  social, 
and  economic  organizations.  They  underlie  every  govern- 
mental, industrial,  and  social  institution.  Without  them  it 
would  be  impossible  to  build  or  maintain  a  prosperous  com- 
munity or  extensive  industrial  organization.  Their  exist- 
ence in  a  permanent,  adequate,  well-organized  form  is 
scarcely  less  important  to  Government  to-day  than  sover- 
eignty itself.  They  are  the  military,  political,  economic 
tools  of  the  Government.  Tbeir  construction,  maintenance, 
and  conduct,  be  it  by  private  individuals  or  public  officials, 
is  essentially  a  public  function,  a  part  of  the  State's  police 
power  based,  not  alone  upon  the  ministration  to  the  public 
welfare,  but  upon  public  safety  and  necessity. 

The  same  general  characteristics  determine  the  status  of 


THE  BASIS  OF  REGULATION  19 

the  wharfinger  and  the  warehouseman.  And  the  considera- 
tions which  made  the  water  system  a  public  utility  have 
placed  the  gas  and  electric  systems  in  that  class.  Storage  is 
communication  between  time  factors,  and  the  services  it 
renders  have  come  to  play  almost  as  important  a  part  in 
modern  industry  as  those  rendered  by  other  communication 
utilities.  Warehousing,  on  account  of  its  relationship  to 
transportation  and  to  the  supply  of  limited  necessities,  has 
a  public  interest  —  the  specific  interest  involved  in  the 
Munn  decision.  Utilities  supplying  necessities,  such  as  wa- 
ter, light,  and  heat  from  a  common  source,  are  as  essential 
to  the  safety  and  welfare  of  the  community,  under  the  mod- 
ern system  of  industrial  and  social  organizations,  as  com- 
munication itself.  Unimportant  sections  may  do  without 
either  service,  but  it  is  impossible  to  conceive  of  a  modern 
metropolis  with  individual  water  supplies,  lighted  by 
candles  or  oil  lamps,  heated  by  stoves  or  ranges.  The  urban 
life,  made  possible  by  the  development  of  the  communicat- 
ing utilities,  has  emphasized  the  public  character  of  and 
developed  new  forms  of  the  limited  necessities  utilities. 

Those  attributes  denominated  "public  interest"  in  the 
Munn  Case  are  found  in  the  final  analysis  of  all  public  utili- 
ties. All  are  necessary  to  the  public  welfare  to  such  an  ex- 
tent that  the  State,  to  reach  its  own  complete  development, 
must  supply  the  service  they  render  or  a  substitute  for  it. 
The  governmental  function,  i.e.,  the  guarantee  of  the  serv- 
ice, with  the  power  to  operate  if  necessary,  as  opposed  to 
the  exercise  of  the  function,  has  never  been  delegated  and 
cannot  be  delegated  without  violation  of  legal  principles.1 

1  Goezler  v.  Georgetown,  6  Wheat.  593;  E.  Hartford  v.  Hartford  Bridge 
Co.,  10  How.  511;  Boyd  v.  Alabama,  94  U.S.  645:  "The  right  to  regulate 
the  charges  of  railroads  for  transportation  is  one  of  the  powers  of  the  State, 
inherent  in  every  sovereignty,  to  be  exercised  by  the  legislature  from  time 
to  time  at  its  pleasure,  and  hence  one  legislature  cannot,  by  a  charter 
granted  to  a  railroad  company,  though  for  valuable  consideration,  confer 
on  such  railroad  company  a  right  to  charge  rates  for  transportation  which 
shall  be  beyond  the  control  of  subsequent  legislatures."  Laurel  Fork  & 
S.H.R.  Co.  v.  West  Virginia  Trans.  Co.,  25  W.Va.  324:  "The  legislature 


20  FAIR  VALUE 

Expediency  alone  has  directed  the  waiver  of  the  right  to 
serve  by  the  State  to  private  capital.  Necessity  has  reserved 
to  the  State  the  right  to  regulate. 

X.  Judicial  Recognition  of  the  Public  Interest 

That  point  in  the  Munn  decision  which  recognizes  the 

public  nature  of  the  utility  business  and  the  resulting  power 

of  regulation  has  been  affirmed  by  the  Supreme  Court  in 

a  long  line  of  cases.1 

cannot,  by  any  contract,  divest  itself  of  the  power  to  provide  for  the 
objects  (preservation  of  good  order  and  the  public  morals).  They  belong 
emphatically  to  that  class  of  objects  which  demand  the  application  of  the 
maxim,  'salus  populi  suprema  lex ' ;  and  they  are  to  be  attained  and  pro- 
vided for  by  such  appropriate  means  as  the  legislative  discretion  may  de- 
vise. That  discretion  can  no  more  be  bargained  away  than  the  power 
itself."  Boston  Beer  Co.  v.  Massachusetts,  97  U.S.  25,  33;  Stone  v.  Miss- 
issippi, 101  U.S.  814, 25  L.  ed.  1079;  Butchers'  Union  Slaughter  House  Co. 
e>.  Crescent  City  Live  Stock  Landing  Co.,  Ill  U.S.  746, 16  Wall.  36;  New 
York  &  N.  E.  R.R.  Co.  v.  Bristol,  151  U.S.  556, 14  Sup.  Ct.  437,  38  L.  ed. 
269;  PearsahV  Great  Northern  Ry.  Co.,  161  U.S.  646, 16  Sup.  Ct.  705;  St. 
Louis  &  S.  F.  R.R.  Co.  v.  Mathews,  165  U.S.  1, 17  Sup.  Ct.  243, 41 L.  ed.  61 1 ; 
New  Orleans  Gaslight  Co.  v.  Drainage  Comm.,  197  U.S.  453,  25  Sup.  Ct. 
471;  Northern  Pacific  R.R.  Co.  v.  Duluth,  208  U.S.  583,  28  Sup.  Ct.  341, 

52  L.  ed.  630;  American  Union  Tel.  Co.  v.  Western  Union  Telg.  Co.,  67 
Ala.  26;  Birmingham  Mineral  R.R.  Co.  v.  Parsons,  100  Ala.  662,  13  So. 
602;  Danville  o.  Danville  Water  Co.,  178  111.  299, 53  N.E.  118,  60  Am.  St. 
Rep.  304,  and  180  111.  235;  Rogers  Park  Water  Co.  v.  Fergus,  178  111.  571, 

53  N.E.  363;  Freeport  Water  Co.  v.  Freeport,  186  111.  179,  57  N.E.  862; 
Venner  v.  Chicago  City  R.R.  Co.,  246  111.  170;  Public  Service  Comm.  of 
Montana  v.  City  of  Helena,  52  Mont.  527,  etc. 

1  Spring  Valley  Water-Works  v.  Schottler,  110  U.S.  347, 4  Sup.  Ct.  48,  24 
L.  ed.  173;  Wabash,  etc.,  R.R.  Co.  v.  Illinois,  118  U.S.  557;  Down.  Beidel- 
man,  125  U.S.  680,  8  Sup.  Ct.  1028;  Georgia  R.  &  Banking  Co.  v.  Smith, 
128  U.S.  174,  9  Sup.  Ct.  47,  32  L.  ed.  377;  Chicago,  Mil.  &  St.  P.  R.R.  Co. 
v.  Minnesota,  134  U.S.  418,  10  Sup.  Ct.  462;  Chicago  &  G.  T.  R.R.  Co.  v. 
Wellman,  143  U.S.  418,  Reagan  v.  Farmers'  Loan  &  Trust  Co.,  154  U.S. 
362, 14  Sup.  Ct.  180,  38  L.  ed.  1014;  St.  Louis  &  S.  F.  R.R.  Co.  v.  Gill,  156 
U.S.  649, 15  Sup.  Ct.  484,  39  L.  ed.  567;  Covington  &  L.  Turnpike  R.R. 
Co.  v.  Sanford,  164  U.S.  578,  17  Sup.  Ct.  198;  Smyth  v.  Ames,  169  U.S. 

466. 18  Sup.  Ct.  418, 42  L.  ed.  819;  Lake  Shore,  etc.,  Ry.  v.  Ohio,  173  U.S. 

285. 19  Sup.  Ct.  465, 43  L.  ed.  702;  San  Diego  Land  &  Town  Co.  v.  National 
City,  174  U.S.  739,  19  Sup.  Ct.  804,  43  L.  ed.  1154;  Chicago,  Mil.  &  St. 
P.  R.R.  Co.  v.  Tompkins,  176  U.S.  167,  44  L.  ed.  418,  20  Sup.  Ct.  336; 
Michigan  Central  R.R.  Co.  v.  Michigan  R.R.  Comm.,  236  U.S.  615,  59 
L.  ed.  750. 


THE  BASIS  OF  REGULATION  21 

In  the  case  of  Brass  v.  North  Dakota 1  the  Court  took  up 
the  issue  where  it  had  left  it  in  the  Munn  decision  and 
thrashed  out  the  monopoly  doctrine  of  regulation.  In  the 
face  of  able  argument  by  counsel  and  a  strong  dissenting 
opinion  based  squarely  on  the  theory  that  virtual  monopoly 
is  necessary  to  warrant  governmental  regulation,  under  the 
doctrine  of  the  Munn  Case,  the  Court  held  that  it  is  the 
public  nature  and  not  the  monopolistic  character  which 
justifies  control  of  a  business  as  a  public  utility.2 

In  Budd  v.  New  York,3  in  a  suit  brought  to  test  the  con- 

1  153  U.S.  391, 14  Sup.  Ct.  857, 38  L.  ed.  757, 4 1.C.C.  Rep.  670. 

2  A  similar  stand  had  been  taken  by  the  Supreme  Court  of  Kentucky 
even  before  the  Munn  decision  in  Nash  v.  Page,  80  Ky.  539,  44  Am.  Rep. 
490,  where  it  was  held  that  the  warehousing  of  tobacco  was  a  public  busi- 
ness because  of  the  importance  of  the  tobacco  industry  to  the  State  and 
the  power  exercised  over  the  industry  by  the  warehouses.  The  question  of 
monopoly  was  not  brought  into  the  case.  It  turned  squarely  on  the  public 
function  theory.  See  also  Delaware,  etc.,  R.R.  v.  Central  Stock  Yd.  Co.  45 
N.J.  Eq.  50,  6  L.R.A.  855;  Belcher,  etc.,  Co.  v.  St.  Louis  Grain  Elevator, 
101  Mo.  192, 13  S.W.  822,  8  L.R.A.  801;  McCullough  p.  Brown,  41  S.C. 
247;  Stewart  v.  Great  N.  Ry.,  65  Minn.  517;  Rippe  v.  Back,  56  Minn. 
108;  Vega  S.S.  Co.  v.  Consol.  Elev.  Co.,  75  Minn.  312,  77  N.W.  973,  43 
L.R.A.  843,  74  Am.  St.  Rep.  484;  etc. 

8  143  U.S.  547,  12  Sup.  Ct.  468.  The  Court  quoted  the  decision  of  the 
lower  court  with  approval,  thus:  "  It  affirmed  that  while  no  general  power 
resided  in  the  legislature  to  regulate  private  business,  prescribe  the  condi- 
tions under  which  it  should  be  conducted,  for  the  price  of  commodities  or 
service,  or  interfere  with  the  freedom  of  contracts  and  while  the  merchant, 
manufacturer,  artisan  and  laborer  under  our  system  of  government,  are 
left  to  pursue  and  provide  for  their  own  interests  in  their  own  way  untram- 
meled  by  burdensome  and  restrictive  regulations,  which,  however  common 
in  rude  and  irregular  times,  are  inconsistent  with  constitutional  liberty, 
yet  there  might  be  special  conditions  and  circumstances  which  brought  the 
business  of  elevating  grain  within  principles  which,  by  the  common  law 
and  the  practice  of  free  governments,  justified  legislative  control  and  regu- 
lation in  the  particular  case,  so  that  the  statute  would  be  constitutional; 
that  the  control  which,  by  common  law  and  by  statute,  was  exercised  over 
common  carriers,  was  conclusive  upon  the  point  that  the  right  of  the  leg- 
islature to  regulate  the  charges  for  service  in  connection  with  the  use  of 
property,  did  not  depend  in  every  case  upon  the  question  whether  there  was  a 
legal  monopoly  or  whether  special  governmental  privileges  or  protection  had 
been  bestowed;  that  there  were  elements  of  publicity  in  the  business  of  elevating 
grain  which  peculiarly  affected  it  with  a  public  interest ;  that  those  elements 
were  found  in  the  nature  and  extent  of  the  business,  its  relation  to  the  com- 


22  FAIR  VALUE 

stitutionality  of  a  New  York  statute  fixing  warehouse  rates, 
the  Court  sustained  the  Munn  Case,  holding  it  in  conform- 
ity with  the  Brass  decision.  The  public  nature  of  the  busi- 
ness, not  the  monopolistic  tendency,  was  held  to  govern. 
The  decision,  however,  adds  little  to  the  previous  holdings. 
In  Cotting  v.  The  Kansas  City  Stock  Yards  et  al.,1  the 
Court  for  the  first  time  since  the  Olcott  Case  distinguishes 
clearly  between  a  private  business  subjected  to  regulation 
and  a  public  business  privately  conducted.  After  reviewing 
in  detail  the  long  line  of  decisions  upholding  the  Munn  Case 
the  Court  said: 

In  the  light  of  these  quotations,  this  may  be  affirmed  to  be  the 
present  scope  of  the  decisions  of  this  Court  in  respect  to  the  power 
of  the  legislature  in  regulating  rates  as  to  those  individuals  and 

merce  of  the  State  and  country  and  the  practical  monopoly  enjoyed  by 
those  engaged  in  it  .  .  .  that  in  view  of  the  foregoing  exceptional  circum- 
stances, the  business  of  elevating  grain  was  affected  with  a  public  interest 
within  the  language  of  Lord  Chief  Justice  Hale,  in  his  treatise  De  Portibus 
Maris  (Haig,  Law  Tracts,  78),  that  the  business  fell  within  the  principle 
which  permitted  the  legislature  to  regulate  the  business  of  common  carriers, 
ferrymen,  and  hackmen,  and  interest  on  the  use  of  money,  and  that  the  un- 
derlying principle  was  that  business  of  certain  kinds  holds  such  a  peculiar 
relation  to  the  public  interest  that  there  is  superinduced  upon  it  the  right 
of  public  regulation;  and  that  the  court  rested  the  power  of  the  legislature  to 
control  and  regulate  elevator  charges  upon  the  nature  and  extent  of  the  business, 
the  existence  of  a  virtual  monopoly,  the  benefit  derived  from  the  Erie  Canal's 
creating  the  business  and  making  it  possible,  the  interest  to  trade  and  com- 
merce, the  relation  of  the  business  to  the  property  and  welfare  of  the  state  and 
the  practice  of  the  legislature  in  analogous  cases,  collectively  creating  an  ex- 
ceptional case  and  justifying  legislative  regulation." 

1  Cotting  v.  Goddard,  183  U.S.  79,  22  Sup.  Ct.  30.  When  a  man  volun- 
tarily undertakes  a  public  service  which  the  State  might  perform,  "He  ex- 
presses his  willingness  to  do  the  work  of  the  State  aware  that  the  State  in  the 
discharge  of  its  public  duties  is  not  guided  solely  by  a  question  of  profit.  It 
may  rightfully  determine  that  the  particular  service  is  of  such  importance  to 
the  public  that  it  may  be  conducted  at  a  pecuniary  loss,  having  in  view  a 
larger  general  interest.  At  any  rate,  it  does  not  perform  its  services  with  the 
single  idea  of  profit.  Its  thought  is  the  general  public  welfare.  If,  in  such  a 
case,  an  individual  is  willing  to  undertake  the  work  of  the  State,  may  it  not 
be  urged  that  he  in  a  measure  subjects  himself  to  the  same  rules  of  action, 
and  that  if  the  body  which  expresses  the  judgment  of  the  State  believes 
that  the  particular  service  should  be  rendered  without  profit,  he  is  not  at 
liberty  to  complain?"  Ibid.  93. 


THE  BASIS  OF  REGULATION  23 

corporations  who  have  devoted  their  property  to  a  use  in  which  the 
public  has  an  interest,  although  not  engaged  in  a  work  of  a  confessedly 
public  character,  there  has  been  no  further  ruling  than  that  the 
State  may  prescribe  and  enforce  reasonable  charges.  What  shall  I 
be  the  test  of  reasonableness  in  those  charges  is  absolutely  undis- 
closed. 

As  to  parties  engaged  in  performing  a  public  service  while  the 
power  to  regulate  has  been  sustained,  negatively,  the  Court  has 
held  that  the  legislature  may  not  prescribe  rates  which  if  enforced  i 
would  amount  to  a  confiscation  of  property.  .  .  . 

In  reference  to  this  latter  class  of  cases  [property  devoted  to  a 
use  affected  with  a  public  interest],  which  is  alone  the  subject 
of  present  inquiry,  it  must  be  noticed  that  the  individual  is  not 
doing  the  work  of  the  State.  He  is  not  using  his  property  in  the 
discharge  of  a  purely  public  service.  He  acquires  from  the  State 
none  of  its  governmental  powers.  His  business  in  all  matters  of 
purchase  and  sale  is  subject  to  the  ordinary  conditions  of  the 
market  and  the  freedom  of  contract  .  .  .  while  he  cannot  claim 
immunity  from  all  State  regulation  he  may  rightfully  say  that  i 
such  regulation  shall  not  operate  to  deprive  him  of  the  ordinary 
privileges  of  others  engaged  in  mercantile  businesses. 

Pursuing  his  thought,  we  add  that  the  State's  regulation  of  his 
charges  is  not  to  be  measured  by  the  aggregate  of  his  profits,  de- 
termined by  the  volume  of  business,  but  by  the  question  whether 
any  particular  charge  to  an  individual  dealing  with  him  is,  con- 
sidering the  service  rendered,  an  unreasonable  exaction.  In  other 
words,  if  he  has  a  thousand  transactionsa  day,  and  his  charges  in 
each  are  but  a  reasonable  compensation  for  the  benefit  received  by 
the  party  dealing  with  him,  such  charges  do  not  become  unreason- 
able because,  by  reason  of  the  multitude,  the  aggregate  of  his 
profits  is  large.  The  question  is  not  how  much  he  makes  out  of  his 
volume  of  business,  but  whether  in  each  particular  transaction 
the  charge  is  an  unreasonable  exaction  for  the  services  rendered. 

The  court  definitely  states  the  public  nature  of  the  busi- 
ness and  points  out  the  difference  in  control  of  a  public  and 
private  undertaking.  The  specific  immediate  reason  for  con- 
trol may  be  monopoly  profit  in  both  cases,  but  need  not  be 
in  public-service  cases.  The  governmental  character  of  the  | 
service  creates  the  distinction  which  submits  the  utility  to 
the  more  rigid  control.  The  public  welfare  can  best  be 
served  by  limiting  individual  rights  in  the  one  case,  and  en- 


24  FAIR  VALUE 

couraging  individual  action  in  the  other  by  refraining  from 
limiting  personal  rights.  The  public  has  an  interest  in  prof- 
its in  the  one  case,  in  rates  and  service  only  in  the  other. 
The  one  operator  has  undertaken  to  discharge  a  govern- 
mental function,  the  other  to  conduct  a  private  business. 

The  only  step  which  remains  is  to  hold  that  a  business 
admittedly  private  may  "become  affected  with  a  public 
interest";  by  change  of  circumstances  which  render  it  of 
such  vital  import  to  the  community  at  large  as  to  make 
it  a  public  calling  and  subject  it  to  the  more  rigid  regu- 
lation. The  German  Alliance  Insurance  Case  decided  by 
the  Supreme  Court  in  1913  x  definitely  affirms  the  first 

1  German  Alliance  Insurance  Co.  v.  Lewis,  233  U.S.  389,  58  L.  ed.  1011, 
42  L.R.A.  (n.s.)  1000.  The  Court  said:  "The  cases  need  no  explanatory  or 
fortifying  comment.  They  demonstrate  that  a  business,  by  circumstances 
and  its  nature,  may  rise  from  private  to  be  of  public  concern,  and  be  subject, 
in  consequence,  to  governmental  regulation.  And  they  demonstrate  .  .  .  that 
the  attempts  made  to  place  the  right  of  public  regulation  in  the  cases  in 
which  it  has  been  exerted,  and  of  which  we  have  given  examples  upon  the 
ground  of  special  privilege  conferred  by  the  public  on  those  affected,  can- 
not be  supported.  The  underlying  principle  is  that  business  of  certain  kinds 
holds  such  a  peculiar  relation  to  the  public  interest  that  there  is  superinduced 
upon  it  the  right  of  public  regidation.  ...  It  would  be  a  bold  thing  to  say 
that  the  principle  is  fixed,  inelastic,  in  the  precedents  of  the  past,  and  can- 
not be  applied  though  modern  economic  conditions  may  make  necessary 
or  beneficial  its  application.  In  other  words,  to  say  that  government  pos- 
sessed at  one  time  a  greater  power  to  recognize  the  public  interest  in  a  busi- 
ness and  its  regulation  to  promote  the  general  welfare  than  government 
possesses  to-day.  .  .  . 

"  It  would  be  very  rudimentary  to  say  that  measures  of  government  are 
determined  by  circumstances,  by  the  presence  or  imminence  of  conditions, 
and  of  the  legislative  judgment  of  the  means  or  the  policy  of  removing  or 
preventing  them.  The  power  to  regulate  interstate  commerce  existed  for  a 
century  before  the  Interstate  Commerce  Act  was  passed,  and  the  commis- 
sion constituted  by  it  was  not  given  authority  to  fix  rates  until  some  years 
afterwards.  Of  the  agencies  which  those  measures  were  enacted  to  regulate 
at  the  time  of  the  creation  of  the  power,  there  was  no  prophecy  or  concep- 
tion. Nor  was  regulation  immediate  upon  their  existence.  It  was  exerted 
only  when  the  size,  number,  and  influence  of  those  agencies  had  so  in- 
creased and  developed  as  to  seem  to  make  it  imperative.  Other  illus- 
trations readily  occur  which  repel  the  intimation  that  the  inactivity 
of  a  power,  however  prolonged,  militates  against  its  legality  when  it  is 
exercised. . . ." 


THE  BASIS  OF  REGULATION  25 

proposition,  and  by  unavoidable  inference  establishes  the 
second. 

This  decision  considered  with  the  Cotting  Case  estab- 
lishes the  fact  that  two  distinct  types  of  industry  may  be 
regulated  under  the  police  power.  The  first  class  includes 
public  utilities  whose  service  is  such  that  the  Government 
must  guarantee  it  to  the  community.  Such  industries  must 
serve  all  comers.  The  service  they  render  is  a  public  one 
which  all  may  demand  as  their  right.  The  public  has  a  di- 
rect interest  in  the  profit  they  make.  The  second  class  con- 
sists of  those  industries,  which  because  of  their  power  to  al- 
ter existing  conditions  of  production  and  distribution  have 
a  direct  influence  upon  the  public  welfare,  but  which  do  not 
exercise  a  governmental  function  or  render  a  service  so  es- 
sential to  the  public  that  the  State  must  guarantee  it.  Such 
business,  in  the  absence  of  statutory  requirement,  need  not 
serve  all  consumers.  It  may  be  required  to  serve  at  reason- 
able rates  when  service  is  rendered,  but  the  public  has  no 
interest  in  its  profits  and  cannot  legislate  for  the  express 
purpose  of  limiting  them. 

XI.  Summary 

To  summarize,  the  basis  of  regulation  is  found  in  the 
theory  of  private  property.  Government  control  is  but  the 
exercise  of  a  necessary  sovereign  power  to  protect  the  pub- 
lic interest  in  private  property.  Such  protection,  though  it 
limits  the  individual  rights,  is  essential  to  the  existence  of 
private  property  itself. 

The  property  which  is  devoted  to  a  public  use,  however, 
is  singled  out  for  more  rigid  control  than  other  private 
wealth.  This  discrimination  is  based  upon  the  fact  that  the 
owner  has  sought  to  make  private  gain  by  rendering  a  gov- 
ernmental service.  He  has  volunteered  for  an  undertaking 
of  such  vital  interest  to  the  public  that  the  Government, 
though  it  has  waived  the  right  to  conduct  the  business  it- 
self, must  see  that  the  service  is  adequately  rendered  at  a 
fair  rate  under  reasonable  conditions. 


26  FAIR  VALUE 

The  property  devoted  to  the  governmental  service  re- 
mains private,  but  because  of  the  peculiar  use  the  public  in- 
terest, present  in  all  private  property,  is  emphasized.  The 
property  is  subjected  to  a  real  encumbrance  which  not 
only  changes  but  decreases  its  value.  So  long  as  the  encum- 
brance exists  the  bundle  of  property  rights  is  diminished. 
The  property  has  undergone  an  actual  change.  Fewer 
rights  exist.  The  social  side  of  the  property  becomes  domi- 
nant because  the  use  is  more  vital  to  society.  The  distinc- 
tive features  of  utility  regulation  are  based  upon  the  neces- 
sity of  protecting  this  public  interest. 


CHAPTER  II 
THE  PURPOSE  OF  REGULATION 

I.  Regulation  and  Private  Interest 

Regulation  is  necessarily  antagonistic  to  the  individual 
interests  regulated.  Government  control  limits  private 
rights.  It  is  negative  and  restrictive,  not  positive  or  con- 
structive. The  police  power,  under  which  regulation  is  ex- 
ercised, is  a  restrictive  power.  The  functions  of  government 
are  qualified  by  the  limitation  that  they  must  promote  the 
public  good  with  the  least  possible  interference  in  private 
affairs.  The  laissez-faire  economic  and  legal  systems,  still 
dominant  in  this  country,  have  emphasized  this  restriction. 
Affirmative  interference,  even  in  the  interest  of  the  public, 
has  been  almost  impossible.  Such  progress  as  has  been  made 
in  protecting  the  social  element  in  private  property  has 
been  possible  only  by  restrictive  action. 

Regulation,  because  it  is  restrictive,  appears  destructive. 
Its  immediate  result  is  destruction,  though  its  ultimate  aim 
and  effect  are  positive  and  constructive.  Regulation  par- 
tially destroys  property  and  property  rights  by  limiting  the 
bundle  of  rights  which  constitute  property.  It  destroys 
individual  freedom  by  limiting  the  use  of  property  and  re- 
straining personal  action.  It  destroys  value  by  destroying 
property  rights,  encumbering  property,  and  limiting  profits. 
Whenever  the  individual  interest  and  the  public  interest 
conflict,  to  such  an  extent  that  regulation  becomes  neces- 
sary, the  individual  interest  is  destroyed  in  whole  or  in  part 
as  expediency  dictates. 

The  aim  of  regulation  is  the  destruction  of  certain  indi- 
vidual rights.  This  fact  cannot  be  too  emphatically  pointed 
out.  Failure  to  recognize  it  has  produced  much  of  the  con- 
fusion in  discussions  of  regulation  and  valuation.  It  has 


28  FAIR  VALUE 

produced  a  widespread  misconception  of  the  "due-process" 
limitation  of  the  Fourteenth  Amendment  by  portraying 
it  as  prohibiting  all  destruction  of  value  without  com- 
pensation. It  has  obscured  both  the  aim  and  basis  of 
regulation. 

The  basis  of  utility  control  is  the  public  interest  in  the 
business,  i.e.,  the  necessity  that  the  common  good  be  pro- 
tected through  the  police  power  by  enforcing  adequate,  con- 
tinuous, non-discriminatory  service  at  reasonable  rates. 
The  aims  of  regulation,  though  negative  and  destructive, 
must  be  similarly  stated  in  terms  of  the  public  welfare. 

II.  Service  Requirements 

The  chief  objective  of  regulation  must  be  adequate  serv- 
ice. Public-service  corporations  are  the  physical  basis  and  \ 
instrumentality  of  all  political,  social,  and  economic  organ- 
ization, and  underlie  every  governmental,  industrial,  and 
social  institution.  Their  existence  in  a  permanent,  adequate, 
well-organized  form  is  essential  to  the  fulfillment  of  the 
purposes  of  government.  They  are  its  military,  political, 
and  economic  tools. 

Adequate  service  can  be  secured  only  when  regulatory 
measures  are  passed  with  this  particular  aim  in  view.  If  the 
community  is  firmly  committed  to  private  ownership,  it 
must  enact  laws  which  will  supply  the  incentive  necessary 
to  induce  capital  to  enter  the  field  in  amounts  sufficient/ 
properly  to  develop  the  service.  Rate  and  financial  legisla- 
tion must  be  adjusted  to  that  end,  or  the  aim  accomplished 
by  subsidies.  Poor  service  and  inadequate  development 
will  follow  unless  such  a  policy  is  adopted,  or  unless  the 
business  is  taken  over  by  the  public.    , 

The  regulatory  system  adopted  must  be  framed  to  secure 
continuous  as  well  as  adequate  service.  Rates  must  provide 
for  accruing  depreciation.  Financial  regulations  and  returns 
must  be  adjusted  to  attract  capital  for  necessary  additions 
and  betterments. 


THE  PURPOSE  OF  REGULATION  29 

III.  Rate  Regulation 

Regulation  cannot  pause  when  adequate  and  continuous 
service  are  secured.  All  forms  of  discrimination  and  rebat- 
ing must  be  prohibited  and  rate  schedules  made  upon  a 
scientific  basis  fair  to  all  consumers. 

The  rates  fixed  must  be  low  enough  to  encourage  general 
use  of  the  service,  or  all  other  features  of  regulation  will  be 
nullified.  This  phase  of  regulation  is  all-important.  It  is 
only  through  general  use  that  the  utility  service  can  build 
up  the  community  and  promote  the  public  welfare.  It  is 
in  part  because  private  interests  may  be  better  served  by 
rendering  a  more  expensive  service  to  few  consumers  than 
by  a  cheaper  service  offered  many  that  regulation  is  neces- 
sary. The  aim  of  government  control  must  be  to  extend  the 
service  as  far  as  it  may  reasonably  be  developed  under  the 
particular  circumstances.  This  aim  makes  rate  regulation 
more  than  a  mere  artificial  enforcement  of  restraints  equiv- 
alent to  those  of  competition. 

IV.  The  Social  Side  of  Regulation 

Important  as  low  rates  are,  however,  the  charges  must 
be  fair  to  the  utility  if  successful  private  operation  is  ex- 
pected. The~cfisputed  question  in  rate  regulation  is,  Shall 
the  schedule  be  drafted  primarily  to  protect  private  prop- 
erty rights  or  to  promote  the  public  welfare?  It  is  because 
this  question  underlies  the  whole  problem  of  utility  con- 
trol that  such  space  has  been  devoted  to  discussion  of  the 
purpose,  dual  nature,  and  legal  status  of  private  property 
devoted  to  a  public  use. 

The  interests  of  the  utility  and  public  are  widely  con- 
ceived of  as  necessarily  antagonistic.  The  short-sighted 
rush  for  gain  by  both  has  made  their  interests  actually 
antagonistic  in  the  past.  A  successful  regulatory  system, 
based  upon  private  operation,  must  recognize  that  the 
utility  and  public  have  many  interests  in  common.  Where 
those  interests  conflict,  public  rights  must  predominate, 


30  FAIR  VALUE 

since  the  whole  purpose  of  regulation  is  to  serve  the  com- 
mon good.  Where  private  property  interests  are  really  ad- 
verse to  the  public  welfare,  they  must  be  destroyed  be- 
cause private  property  itself  exists  only  to  promote  the 
public  good  and  private  interests  can  be  furthered  only 
by  promotion  of  the  common  weal.  The  moment  the  indi- 
vidualistic side  of  private  property  is  emphasized  at  the 
expense  of  the  social  side,  the  fundamental  property  rights 
themselves  are  threatened.  If  the  question  is  vital  the  so- 
cial interest  must  predominate. 

The  social-welfare  element,  therefore,  is  constantly  be- 
coming more  prominent  in  regulation.  No  well-balanced 
regulatory  system  can  neglect  it.  Commutation  fares 
must  be  offered  to  counteract  the  congestion  of  population 
in  thickly  settled  city  districts.  Reduced  transportation 
rates  should  be  secured  for  school-children.  Transportation, 
gas,  and  electric  charges  should  be  reduced  to  encourage 
general  use  of  the  service,  develop  the  community,  foster 
industry,  and  raise  the  general  standard  of  living.  Trans- 
portation rate  schedules  and  classifications  must  be  drafted 
to  encourage  the  movement  of  low-class  freight  and  raw 
material  to  aid  production,  and  to  encourage  immigration 
to  assist  in  the  distribution  of  population.  The  primary  ob- 
ject of  regulation  is  the  economic  betterment  of  society. 

The  purpose  of  regulation  is  apparent.  The  expedient 
means  are  determined  with  greater  difficulty,  especially 
when  the  property  employed  in  the  public  service  is  pri- 
vate. The  system  of  private  operation  is  essentially  a  lim- 
itation upon  the  pure  public-welfare  theory.  It  is  far  from 
inconceivable  that  the  public  interest  may  demand  opera- 
tion at  an  unremunerative  rate,  even  after  the  development 
period  of  the  service  has  passed.  It  might  be  deemed  a  wise 
legislative  policy  to  supply  cheap  transportation,  light, 
heat,  power,  or  water  to  raise  the  standard  of  living,  develop 
the  community,  build  up  an  industrial  center,  attract  pop- 
ulation, and  lower  the  price  of  manufactured  goods.  Such 


THE  PURPOSE  OF  REGULATION  SI 

legislation  accords  with  present  theories  of  social  better- 
ment, has  been  widely  experimented  with  on  the  Conti- 
nent, and  is  not  unknown  in  this  country.  But  private 
ownership  is  poorly  adapted  to  such  a  programme  because 
an  adequate  return  upon  the  capital  invested  is  the  first  es-  J 
sential  of  such  a  system.  Social  and  economic  betterment 
rates  not  remunerative  to  the  utility  owners  can  be  se- 
cured only  by  way  of  subsidizing  the  plant;  and  subsidies 
are  not  looked  upon  with  favor,  have  not  proved  satisfac- 
tory, and  are  necessarily  indirect  and  open  to  misuse.  Pub- 
lic ownership,  though  not  always  expedient,  is  the  only 
logical  solution  of  the  social  betterment  problem. 

V.  Northern  Pacific  Railway  v.  North  Dakota 

The  adoption  of  private  ownership  of  utility  property  in 
the  United  States  has  not,  however,  completely  closed  the 
door  to  social-welfare  regulation.  The  decision  which  limits 
public  and  entrenches  private  interest  most  is  Northern 
Pacific  Railway  v.  North  Dakota,1  reversing  Minnesota  and 
St.  Louis  Railroad  v.  Minnesota.2  In  the  Dakota  Case  the 

1  236  U.S.  585,  59  L.  ed.  735. 

2  186  U.S.  257,  46  L.  ed.  1151,  22  Sup.  Ct.  901.  The  Court  said:  "But, 
while  local  interests  may  serve  as  a  motive  for  enforcing  reasonable  rates, 
it  would  be  a  very  different  matter  to  say  that  the  State  may  compel  a 
carrier  to  maintain  a  rate  upon  a  particular  commodity  that  is  less  than 
reasonable  or  —  as  it  might  equally  well  be  asserted  —  gratuitously,  in  or- 
der to  build  up  a  local  enterprise.  .  .  .  The  fact  that  the  property  is  devoted 
to  a  public  use  on  certain  terms  does  not  justify  the  requirement  that  it 
shall  be  devoted  to  other  public  purposes.  .  .  .  The  public  interest  cannot 
be  invoked  as  justification  for  demands  which  pass  the  limits  of  reasonable 
protection  and  seek  to  impose  upon  the  carrier  and  its  property  burdens 
that  are  not  incident  to  its  engagement. 

"Where  it  is  established  that  a  commodity,  or  class  of  traffic,  has  been 
segregated  and  a  rate  imposed  which  would  compel  the  carrier  to  trans- 
port it  for  less  than  the  proper  cost  of  transportation,  or  virtually  at  cost, 
and  thus  the  carrier  would  be  denied  a  reasonable  reward  for  its  service 
after  taking  into  account  the  entire  traffic  to  which  the  rate  applies,  it 
must  be  concluded  that  the  State  has  exceeded  its  authority. 

"  //  in  such  a  case  there  exists  any  practice,  or  what  may  be  taken  to  be 
(broadly  speaking)  a  standard  of  rates  with  respect  to  that  traffic,  in  the  light  of 
which  it  is  insisted  that  the  rate  should  still  be  regarded  as  reasonable,  that 


32  FAIR  VALUE 

Court  ruled  that  it  is  not  sufficient  protection  to  private 
rights  to  grant  an  adequate  return  upon  the  [whole  schedule, 
but  that  each  rate  must  provide  a  reasonable  return  for  the 
service  rendered. 

Even  this  ruling,  however,  leaves  opportunity  for  limited 
social-betterment  rate-making.  The  Court  merely  holds 
that  the  rate  must  produce  some  return  above  the  fair  cost 
of  the  service  —  an  income  reasonable  for  the  kind  of  traffic 
carried.  The  decision  leaves  room  to  draft  rates  to  encour- 
age the  movement  of  low-class  freight,  since  a  rate  for  such 
traffic  might  be  held  reasonable,  though  far  below  a  figure 
justifiable  for  other  goods. 

Much  may  be  accomplished  by  adjusting  the  rate  of  re- 
turn.1 Social-welfare  principles  may  be  applied  to  fix  the 
percentage  in  each  case. 

A  recent  decision  2  holds  that  an  order  compelling  a  trac- 
tion company  to  carry  passengers  at  a  loss  over  lines  oper- 
ated under  a  separate  franchise,  but  as  a  part  of  a  general 
system,  was  not  a  violation  of  the  due-process  clause  if  a 
reasonable  income  was  earned  upon  the  whole  system.  A 
similar  rule  was  laid  down  in  the  case  of  St.  Louis,  etc., 
Railroad  Company  v.  Gill.3 

An  analogous  rule  has  been  adopted  in  the  case  of  service 

should  be  made  to  appear."  This  case  has  been  approved  by  a  long  line  of 
subsequent  holdings,  largely,  however,  commission  cases.  See  Norfolk  and 
Western  Ry.  v.  Conley,  236  U.S.  605,  59  L.  ed.  745;  Union  Pacific  R.R. 
Co.  v.  Public  Utilities  Comm.  of  Kansas,  P.U.R.  1915-D-377;  In  re  N.E. 
Kansas  Tel.  Co.,  P.U.R.  1916-B-925;  Butler  v.  Lewiston,  A.  &  W.  St.  Ry. 
Co.  (Me.)  P.U.R.  1916-D-25. 

1  In  commenting  on  Northern  Pacific  Ry.  Co.  v.  North  Dakota  the 
Court  said,  in  Norfolk  and  Western  Ry.  v.  Conley,  236  U.S.  605,  59  L. 
ed.  735:  "It  was  recognized  that  th»  State  has  a  broad  field  for  the  exer- 
cise of  its  discretion  in  prescribing  reasonable  rates  for  common  carriers 
within  its  jurisdiction;  that  it  is  not  necessary  that  there  should  be  uni- 
form rates  or  the  same  percentage  of  profit  on  every  sort  of  business; 
and  that  there  is  abundant  room  for  reasonable  classification  and  the 
adaptation  of  rates  to  various  groups  of  service." 

2  Puget  Sound  Trac.  L.  &  P.  Co.  v.  Reynolds  et  al.,  244  U.S.  574,  579, 
61  L.  ed.  1325. 

8  156  U.S.  649,  15  Sup.  Ct.  484,  39  L.  ed.  567. 


THE  PURPOSE  OF  REGULATION  33 

orders.  The  Court  has  sustained  rulings  requiring  utilities 
to  install  additional  facilities  and  render  more  adequate 
service  even  at  a  loss,  where  the  company  was  expressly 
or  impliedly  obligated  by  its  franchise  privileges  to  meet 
such  requirements.1 

Thus,  while  the  operation  of  the  social-welfare  principle 
in  rate-making  is  very  much  restricted,  it  is  not  wholly 
blocked  by  private  ownership.  It  may  be  successfully  ap- 
plied, within  the  limits  stated,  to  railway  rates  in  general,2 
without  violating  the  prohibitions  of  the  Fourteenth  Amend- 
ment. It  may  be  applied  with  even  wider  results  to  other 
utility  rates.  It  must,  under  the  changing  economic  and 
social  theories,  become  ever  more  and  more  a  feature  of 
control  if  government  ownership  and  operation  are  to  be 
avoided. 

VI.  Anti-Monopoly  Regulation 

Encouragement  of  extensive  use  of  service  by  fixing  rea- 
sonable charges  is  of  great  import,  but  cheap  rates  are  not 
the  chief  aim  of  regulation.  Nearly  every  decision  has  in- 

1  Atlantic  Coast  Line  v.  N.  Carolina  Corp.  Comm.,  206  U.S.  1,  51  L. 
ed.  933;  see  also  Wisconsin  Ry.  Co.  v.  Jackson,  179  U.S.  287,  45  L.  ed. 
194,  21  Sup.  Ct.  115;  Louisville  &  Nashville  R.R.  v.  Kentucky,  183  U.S. 
503,  22  Sup.  Ct.  95. 

2  "  Undoubtedly  the  cost  of  service  represents  the  most  important  and  in 
many  ways  the  fairest  basis  for  fixing  rates,  but  this  basis  cannot  in  all  cases 
be  inflexibly  applied,  owing  to  the  economic  necessity  for  moving  certain 
traffic  which  could  not  be  handled  at  all  except  at  a  relatively  low  rate." 
Railroad  Passenger  Rate  Case  (Mass.)  P.U.R.  1915-B-362, 367. 

"The  general  comparatively  low  rating  [of  low-class  commodities]  is 
largely  due  to  the  character  of  such  commodities,  the  use  to  which  they 
are  put,  the  demand  for  them  in  large  quantities  throughout  the  country, 
their  susceptibility  of  movement  at  less  cost  and  risk  to  the  carrier  than 
high-class  and  more  valuable  freight,  and  other  like  considerations.  It  is  to 
the  interest  of  the  carrier  as  well  as  the  public  that  their  rates  be  low  enough^ 
if  not  below  a  remunerative  point,  to  permit  the  general  movement  and  distri- 
bution of  these  commodities  in  general  demand  in  large  quantities  for 
construction,  building,  manufacturing,  and  other  purposes.  Reasonable 
freedom  of  such  movement  and  distribution  stimulates  the  growth  and 
development  of  the  country  and  thereby  promotes  all  interests."  Colorado 
Fuel  &  I.  Co.  v.  Southern  Pac.  Ry.  Co.,  6  I.C.C.  489. 


34  FAIR  VALUE 

volved  and  emphasized  the  rate  question,  because,  under 
the  laissez-faire  policy,  prices  in  the  monopolistic  utility 
field  were  invariably  above  the  reasonable  figure. 

The  agitation  which  resulted  in  the  Granger  movement 
was  one  to  reduce  charges.  The  low  competitive  rates 
forced  from  interstate  utilities  by  the  industrial  centers 
made  the  higher  non-competitive  rates  charged  the  Illinois 
and  Iowa  farmers  seem  unreasonably  high.  The  fall  in 
prices  on  the  farmers'  products  coming  just  at  this  time 
emphasized  this  phase  of  the  dissatisfaction.  Rebates  and 
individual  discrimination  were  overlooked.  A  remedy  for 
the  rate  situation  was  sought  in  maximum-rate  legislation. 

The  movement  was  not  a  complete  reaction  against  the 
laissez-faire  policy.  The  aim  was  to  regulate  monopoly  and 
curb  unreasonable  profits.  As  the  movement  gained  mo- 
mentum it  broadened  to  include  a  cure  for  rebates,  unjust 
discrimination  between  persons  and  localities,  and  the  many 
other  evils  of  monopoly. 

The  period  was  anti-monopolistic.  Competition  was 
considered  a  sufficient  force,  if  properly  fostered,  to  regu- 
late monopoly  profits,  confine  corporate  growth  within  the 
bounds  of  safety,  and  generally  protect  the  public.  The  aim 
of  regulation  was  to  curb  monopoly,  to  foster  competition,  I 
and  to  eliminate  monopoly  profits.  The  regulation  sug- 
gested was  very  similar  to  that  since  applied  to  the  whole 
field  of  general  industry,  but  declared  inexpedient  in  the 
case  of  public-service  companies. 

VII.   The  Recognition  of  Regulated  Monopoly 

Since  1910  there  has  occurred  a  complete  change  in  the 
aims  of  public-utility  regulation.  The  competitive  theory 
has  been  practically  abandoned.  The  present  movement 
recognizes  monopoly,  particularly  natural  and  legal  monop- 
oly, as  a  desirable  element  in  the  field  and  seeks  to  regulate 
rather  than  destroy  it.  The  day  of  regulation  by  competi- 
tion in  the  field  of  public  service  has  passed.  Monopoly  has 


THE  PURPOSE  OF  REGULATION  35 

come  to  stay.  Regulation  has  replaced  competition,  but  not 
as  a  mere  artificial  competition  installed  because  of  the  ab- 
sence of,  or  undesirability  of,  the  real  element. 

The  force  of  competition  as  a  regulatory  element  in  rate 
control  rests  on  the  fact  that  when  competition  in  any  form 
is  present,  the  rate  will  ultimately  be  forced,  not  to  the 
mean  figure  which  will  yield  the  greatest  return,  but  below 
that  figure  to  approximately  the  cost  of  rendering  the  serv- 
ice by  the  most  disadvantageously  located  competitor. 
This  is  true  because  if  a  higher  rate  is  charged,  the  mar- 
ginal producer  who  is  struggling  for  existence  will  sell  lower 
and  supply  the  demand,  and  new  capital  will  be  drawn  into 
the  industry,  thus  forcing  the  price  down.  The  normal  price 
under  free  competitive  production  and  the  only  price  which 
can  be  stable  in  case  of  such  production  is  one  which  approx- 
imates the  cost  of  production. 

The  competitive  rate,  therefore,  is  always  below  the  un- 
regulated monopolistic  rate  under  the  same  productive  con- 
ditions. Moreover,  the  competitive  theory  fitted  well  to  the 
ragged  ends  of  the  previous  laissez-faire  policy.  It  complied 
with  the  demands  of  those  who  held  exalted  ideas  of  the  sa- 
credness  of  private  property  and  business  rights.  It  required 
no  effort.  It  was  conservative  regulation;  and  it  was  adopted. 
It  was  held  on  to  tenaciously  because  it  was  conservative, 
because  it  did  conform  to  ideas  of  industrial  freedom,  and 
because  where  competition  existed  it  did  lower  rates. 

During  the  earlier  period  of  regulation  no  effective  check 
was  placed  upon  monopoly.  None  was  known,  and  monop- 
oly was  feared  because  it  could  not  be  controlled.  The  pe- 
riod of  the  usefulness  of  uncontrolled  monopoly  passed,  but 
careful  fostering  during  that  period  had  developed  legal 
entities  of  seeming  gigantic  proportions,  which  rode  over 
both  competition  and  legislation.  Regulatory  bodies  saw  no 
loophole  toward  successful  control  save  abolishing  abso- 
lutely and  forever  the  object  they  deemed  themselves  in- 
capable of  controlling.  Competition  stood  forth  a  shining 


36  FAIR  VALUE 

relic  of  past  glory,  an  idea  to  be  sought  above  all  else.  The 
struggle  to  reinstate  this  fallen  idol  brought  self-assurance, 
brought  legislative  experience,  and  has  led  to  the  present 
altered  aim. 

VIII.   The  Reasons  for  the  Change 

The  reasons  for  the  change  from  the  competitive  theory 
to  the  recognition  of  regulated  monopoly  in  the  utility 
field  are  not  difficult  to  discover.  Where  virtual  monopoly 
exists,  the  competitive  force  fixing  price  near  the  cost  of 
production  is  lacking.  If  rates  are  limited  the  restriction 
must  be  imposed  by  government  regulation.  The  public- 
utility  company  is  monopolistic  because  duplication  of 
facilities  and  the  uncertainty  of  competitive  service  are  not 
conducive  to  the  greatest  possible  public  benefits.  Often 
the  utility  combines  both  natural  and  legal  monopoly.  In 
fact,  the  two  differ  in  little  but  name  in  the  public  service 
field,  since  natural  monopoly  seldom  means  real  inability 
to  duplicate  facilities  or  offer  substitute  service;  in  truth 
means  little  but  the  inexpediency  of  granting  more  than  one 
permit  to  use  natural  facilities.  The  territory  served  can- 
not afford  an  unnecessary  duplication  of  rights  of  way,  of 
wires,  conduits,  pipes,  and  rails,  particularly  where  such 
facilities  are  located  in,  above,  or  below  its  streets.  A  legal 
monopoly  is  granted.  The  securing  of  a  duplicate  right  of 
way  becomes,  in  most  cases,  practically  impossible,  and  so 
expensive  as  to  produce  virtual  monopoly  for  the  first  com- 
pany in  the  field.  Duplication  always  multiplies  the  capital 
expenditure  upon  which  a  return  must  be  provided  by  the 
rates.  And  at  the  same  time  it  decreases  the  number  of  con- 
sumers who  must  pay  the  charges,  thus  raising  the  pro-rata 
share  of  each. 

The  service  which  a  public  utility  renders  is  usually  not 
in  competition  with  any  substitute  service,  and  competi- 
tion between  similar  utilities  is  undesirable.  Competition 
could  not  be  accepted  as  a  permanent  regulatory  force  be- 


THE  PURPOSE  OF  REGULATION  37 

cause  the  corporations  to  be  controlled  were  best  operated 
as  monopolies.  The  competitive  theory  has  had  no  real 
place  in  regulation  since  the  advantages  of  monopolistic 
operation  became  apparent. 

It  is  questionable  whether,  under  modern  industrial  con- 
ditions, the  competitive  theory  of  regulation  could  be  suc- 
cessfully applied  even  in  the  absence  of  natural  and  legal 
monopoly.  Competition  keeps  rates  near  the  cost  of  pro- 
duction, but  also  keeps  that  cost  needlessly  high.  This  is 
particularly  true  in  the  case  of  distributive  services  such  as 
water,  gas,  electricity,  telegraph,  telephone,  and  common 
carriage.  A  great  part  of  the  cost  of  service  in  such  under- 
takings is  connected  with  the  stringing  of  wires,  laying  of 
mains,  or  construction  of  roadbed  and  track.  Any  duplica- 
tion of  this  non-productive  distribution  system  is  a  burden 
upon  the  community  which  nearly  if  not  completely  elimi- 
nates the  possibility  of  lowering  rates  by  way  of  competi- 
tion. The  cost  of  production  would  raise  the  competitive 
rate  above  the  monopolistic  charge  of  a  favorably  located 
single  company.  The  funds  wasted  in  needless  and  unpro- 
ductive duplication  could  be  used  by  a  single  concern  to 
extend  its  mains  or  wires  into  areas  which  could  not  be 
reached  at  all  if  two  companies  occupied  the  field. 

Competition  is  a  defective  regulatory  force,  under  pres- 
ent conditions,  because  it  does  not  foster  the  public  interest 
in  the  undertaking  and  does  not, take  social  welfare  into 
consideration.  Although  recognizing  a  difference  between 
the  public  utility  and  other  industry  which  justifies  regula- 
tion of  a  different  type,  the  competitive  theory  proceeds 
to  disregard  that  difference  and  apply  the  same  control  to 
utilities  and  other  industry. 

Competition  for  these  reasons  has  proven  a  regulatory 
force  unsatisfactory  to  both  the  utility  and  the  public. 
Monopoly  has  been  accepted  as  the  economic  substitute 
to  eliminate  the  wastes  of  competition,  but  accepted  sub- 
ject to  regulation  to  secure  the  benefits  which  competition 


38  FAIR  VALUE 

would  have  given  and  to  guarantee  to  the  public  its  share 
of  the  savings  from  monopolistic  operation. 

The  changed  attitude  of  regulatory  bodies  toward  monop- 
oly is  clearly  expressed  by  the  Public  Utilities  Commis- 
sion of  Illinois  in  the  case  of  the  Lake  Shore  and  Michigan 
Southern  Railway  Company,1  wherein  the  Commission 
said: 

The  consolidation  will,  of  course,  result  in  the  formation  of  a 
corporation  of  great  magnitude  with  immense  power  which  might, 
in  the  absence  of  reasonable  governmental  supervision  and  con- 
trol over  its  dealings  with  the  public,  exercise  evil  influences  on 
government,  or  become  oppressive  to  the  public;  but  the  dangers 
because  of  bigness  which  might  be  apprehended  if  unbridled  free- 
dom were  to  follow,  cannot  be  regarded  as  a  menace  when  the 
greater  power  of  the  Government  to  regulate  and  control  it  is 
properly  exerted  to  prevent  wrong  and  injustice. 

This  Commission  is  not  opposed  to  unification,  merger,  or  con- 
solidation of  public-service  corporations  in  Illinois  when  the  same 
can  be  effected  without  violating  some  positive  law.  The  constitu- 
tional and  statutory  inhibitions  against  monopolies  were  designed 
to  preserve  to  the  public  such  benefits  as  would  accrue  from  com- 
petition. Under  the  Public-Utilities  Law  of  Illinois,  however,  am- 
ple provision  is  made  to  safeguard  more  fully  the  interests  of  the 
public  through  and  by  a  commission  organized  to  supervise,  regu- 
late, and  control  all  public-service  corporations  in  the  matter  of 
reasonableness  of  rates  to  be  charged,  the  adequacy  of  the  service 

1  I.P.U.C.  No.  2495;  see  also  State  Pub.  Utilities  Comm.  ex  rel.  Clow 
v.  Romberg  (111.  Sup.  Ct.)  P.U.R.  1917-B-355;  State  Public  Utilities 
Comm.  ex  rel.  Pike  County  Tel.  Co.  v.  Noble,  275  111.  121,  P.U.R. 
1917-A-520.  The  State  regulatory  commissions  are  unanimous  in  their 
acceptance  of  regulated  monopoly. 

"The  enactment  clearly  constitutes  an  expression  of  the  legislative  pol- 
icy which,  recognizing  the  evils  which  flow  from  duplication  of  the  equip- 
ment and  facilities  of  public  utilities,  declares  that  regulated  monopoly  is 
preferable  to  unrestricted  competition  in  which  the  possibilities  for  waste 
and  dissatisfaction  are  limited  only  by  the  resources  of  the  rivals  and  the 
patience  of  the  consumers.  The  clear  intent  of  the  statute,  as  has  been  said  in 
numerous  decisions,  is  to  -prevent  competition  in  any  given  field  so  long  as  the 
existing  facilities  are  adequate  or  can  be  made  so  by  the  exercise  of  the 
supervisory  and  corrective  jurisdiction  of  this  commission,"  Theresa  Union 
Tel.  Co.  v.  East  Valley  Tel.  Co.  (Wis.)  P.U.R.  1917-E-387, 394;  Ft.  Supply 
T.  &  T.  Co.  v.  Pioneer  T.  &  T.  Co.  P.U.R.  1917-A-188, 191. 


THE  PURPOSE  OF  REGULATION  39 

to  be  rendered,  and  in  the  prevention  of  discrimination  as  to  both 
rates  and  service. 

Formerly  without  reasonable  regulation  and  control  of  public- 
service  corporations  competition  seemed  to  be  the  only  method  by 
which  the  public  interests  could  be  protected,  but  with  such  com- 
prehensive regulatory  laws  as  are  now  in  force  in  this  state  competi- 
tion loses  its  forces  as  a  corrective  agency. 

Monopoly  having  been  accepted  in  the  field  of  public- 
utility  service,  the  aim  of  future  government  regulation 
must  include  the  weeding-out  of  those  natural  evils  which 
have  characterized  monopoly  in  the  past.  Rates  must  be 
controlled  to  keep  them  near  the  cost  of  production.  Operat- 
ing expenses  must  be  supervised  to  keep  the  cost  of  pro- 
duction low,  and  the  accounting  and  financial  activities  of 
the  companies  must  be  regulated  to  prevent  circumvention 
of  regulation. 

It  is  not  the  evils  of  monopoly  alone,  however,  which 
must  be  guarded  against  under  a  system  of  regulated  mo- 
nopoly. Competition  must  be  eliminated  to  prevent  need- 
less duplication  and  waste.  The  regulatory  force  of  com- 
petition must  be  saved,  advantage  taken  of  the  economic 
benefits  of  monopoly,  and  the  public  interest  substituted 
for  that  of  the  individual  competitor.  \. 


IX.  Speculation 

The  most  prominent  phase  of  regulation  outside  the 
sphere  of  monopoly  is  the  control  of  speculation.  In  this 
field,  as  in  that  of  monopoly,  the  dangers  were  learned  early. 
The  great  development  company  bubbles  and  lotteries 
taught  the  lesson.  Here,  too,  early  conditions  were  unfa- 
vorable to  regulation.  Utility  undertakings  had  to  be  given 
the  glamour  of  speculation  to  attract  private  capital  and 
encourage  rush  construction.  Speculation  in  the  public- 
utility  field  was  more  pronounced  than  elsewhere.  It  had 
run  its  course  in  other  industries  when  the  public-service 
field  was  opened.  There  had  been  wild-cat  banking,  land 
booms,  and  industrial  bubbles.  In  these  fields  the  specula- 


40  FAIR  VALUE 

tor  was  forced  to  play  a  game  the  people  knew,  but  the  pub- 
lic-utility business  was  new.  The  changes  affected  by  its 
development  were  as  revolutionary  as  the  business  itself. 
The  appeal  of  unlimited  profits  could  be  made. 

The  utility  field  was  unoccupied.  It  offered  temptations 
to  the  speculator  which  no  sphere  already  developed  could 
hold  out.  The  public  demanded  the  service.  There  was  a 
vast  territory  which  required  the  utility  for  its  develop- 
ment. The  eagerness  of  the  people  made  them  the  easy  prey 
of  the  promoter.  Land  grants,  bond  issues,  and  subsidies 
were  secured  without  difficulty.  And  the  development  of 
new  territory  opened  the  door  to  unlimited  wealth,  by  way 
of  collateral  investment,  to  the  man  on  the  spot  and  on  the 
inside  of  the  development  organization. 

No  one  of  all  these  forces  which  drew  speculators  from 
other  fields,  however,  was  inherent  in  the  nature  of  the 
public-utility  business.  The  utility  differs  from  other  in- 
dustry, so  far  as  speculation  is  concerned,  only  in  the  harm 
which  flows  from  inefficient  control  on  account  of  the  pub- 
lic nature  of  the  business.  Effective  regulation  in  the  public 
interest  would  be  impossible  if  the  law  permitted  the  utility 
to  be  made  the  pawn  in  ajspeculative  game.  Rate  control, 
based  upon  true  economic  principlesr^oes  much  to  elimi-  [ 
nate  the  speculative  element,  but  valuation  not  based  on* 
such  principles  reopens  the  door  to  the  speculator  and  en- 
dangers the  interests  of  stockholders,  bondholders,  and 
consumers. 

Adequate,  uninterrupted  service  can  scarcely  be  ex- 
pected, even  under  compulsion,  when  the  undertaking  is  a 
speculation  rather  than  a  sound  business  proposition.  The 
public  interest  and  that  of  the  gambler  in  utility  securities 
and  utility  service  are  wholly  dissimilar.  Regulation  can  be 
made  effective  only  by  eliminating  speculation  and  uncer- 
tainty and  placing  the  service  on  an  economic  basis.  Com- 
petition, even  in  a  non-monopolistic  field,  cannot  check 
speculation,  for  competition  is  itself  speculative  and  un- 


THE  PURPOSE  OF  REGULATION  41 

certain.  The  competitor  entering  a  field  already  occupied 
plays  a  spectacular  game  of  chance  staking  his  self-confi- 
dence, an  invention  or  a  newer  process  against  the  train- 
ing and  going  value  of  the  existing  concern. 

X.  Efficient  Management 

Rate  schedules  and  financial  legislation  formed  to  pro- 
duce a  return  that  will  attract  capital,  and  at  the  same  time 
keep  the  price  of  service  near  the  cost  of  producing  it,  would 
prove  ineffectual  if  that  cost  were  permitted  to  be  unduly 
enhanced  either  by  unnecessary  capital  expenditures  or 
unreasonable  operating  expenses.  Any  effective  regulatory 
system  must  enforce  efficient  management.  And  efficient 
management  can  be  insured  only  by  means  of  a  thorough, 
compulsory  cost  system.  It  is  impossible  to  regulate  scientif- 
ically on  any  other  basis.  Rate  regulation  must  be  founded 
on  cost.  Depreciation  must  be  accurately  estimated  and 
provided  for,  and  working  capital  held  in  proper  ratio  to 
investment  and  service.  Cost  must  be  itemized  to  show 
proper  operation  as  a  basis  for  credit,  and  point  out  possi- 
ble savings  in  material  and  labor. 

Regulation  must  attempt  to  produce  a  capitalization 
reasonable  in  relation  to  the  service  performed  and  the  cir- 
cumstances under  which  it  is  rendered.  It  must  aim  to  keep 
operating  expenses  at  a  reasonable  figure  considering  those 
same  elements.  False  capitalization,  stock- watering,  and 
sharp  financial  practices  must  be  eliminated. 

Regulation  must  be  shaped  to  counteract  what  Professor 
Clark  has  spoken  of  as  the  failure  of  monopoly  to  make  a 
"proper  use  of  that  invaluable  agent  of  progress,  the  junk 
heap."1  This  aim  may  be  accomplished  by  providing  a 
compulsory  depreciation  fund  unavailable  for  general  use 
to  offset  the  temptation  to  keep  worn-out  or  antiquated 
equipment  in  service.  Such  requirements  should  be  supple- 
mented by  positive  rules  as  to  new  equipment,  construction, 
1  Clark,  The  Control  of  Trusts,  2d  ed.  p.  14. 


42  FAIR  VALUE 

and  standards  of  service,  and  by  manipulation  of  the  rate 
of  return  to  reward  economic  management. 

Control  must  be  exercised  to  prevent  unnecessary  salary 
expenditure,  unreasonable  interference  by  holding  compa- 
nies, irrational  investments  in  material  and  supplies,  idle 
property,  excessive  and  poorly  adapted  or  antiquated 
equipment;  to  curb  loss  by  leakage;  to  secure  efficient  or- 
ganization and  business  methods;  to  limit  the  size  of  the 
corporation  and  the  territory  covered,  etc.  Regulation 
should  not  amount  to  management,  but  it  cannot  permit 
management  to  defeat  regulation. 

XI.  Financial  Regulation 

Any  system  of  regulation  which  neglected  the  financial 
transactions  of  the  utilities  would  be  powerless  to  check 
speculation.  Such  a  state  of  things  would  hopelessly  handi- 
cap rate-making.  It  would  render  attempts  to  force  effi- 
cient management  futile. 

Security  issues  must  be  permitted  only  upon  a  showing 
of  actual  need  for  further  capitalization,  proof  of  the  ex- 
pediency of  the  type  of  financing  proposed,  and  the  proper 
ratio  of  stock  to  bonds,  etc.  The  terms  of  sale  must  be  fixed 
to  assure  an  adequate  return,  and  the  sale  expenses  amor- 
tized from  income  to  prevent  a  padded  capital  account. 
Where  the  aim  is  to  secure  funds  for  additions  and  better- 
ments the  propriety  of  the  form  and  extent  of  equipment  or 
construction  must  be  determined. 

In  the  case  of  purchase  and  sale  the  capitalization  of  the 
purchasing  company  must  be  limited  to  the  fair  value  of  the 
property,  irrespective  of  the  sale  price,  and  the  price  must 
be  held  to  approximately  the  fair  value,  to  prevent  handi- 
capping the  company  by  an  excessive  expenditure  on  which 
a  return  cannot  be  earned.  Where  a  part  of  the  utility's 
property  is  sold  a  corresponding  decrease  in  capitalization 
must  be  enforced  or  the  resulting  deficiency  made  good  by 
additions  and  betterments  not  charged  to  capital. 


THE  PURPOSE  OF  REGULATION  43 

In  the  case  of  a  reorganization  the  capitalization  must  be 
limited  to  the  fair  value  of  the  property,  and  where  consoli- 
dation occurs  capital  must  be  restricted  to  the  sum  of  the 
outstanding  securities  of  the  consolidated  companies  plus 
any  additional  capital  actually  invested  at  the  time  of  con- 
solidation.1 

XII.  Accounting 

The  accounting  features  are  among  the  most  important 
of  the  regulatory  programme.  Proper  accounting  methods 
and  investigations  are  the  basis  of  publicity,  of  financial 
regulation,  of  rate  valuation,  of  every  feature  of  control.  A 
uniform  system  of  public-utility  accounts  is  absolutely 
necessary  to  show  the  service  records,  earnings,  expenses, 
and  real  investment.  It  alone  can  make  possible  reliable 
comparison  between  utilities  to  show  where  economies  may 
be  effected  or  to  test  reasonableness  of  charges.  It  only  can 
serve  as  the  basis  of  the  cost  system  upon  which  all  regula- 
tion is  founded. 

In  the  case  of  issues  of  securities  the  accounting  system 
must  show  the  existing  capitalization,  the  need  for  further 
securities,  the  ratio  of  stock  to  bonds,  and  the  expedient 
form  of  security.  It  must  follow  the  expenditure  of  the  pro- 
ceeds from  the  sale.  It  must  enable  regulation  to  protect 
both  the  investor  and  the  consumer. 

In  the  case  of  rate  investigations  the  accuracy  of  the  orig- 
inal-cost inventory  depends  upon  the  accounts  required 
by  the  regulatory  system.  The  estimate  of  operating  ex- 
penses and  working  capital  and  the  traffic  survey  are  de- 
pendent upon  the  accuracy  of  the  accounts.  The  trustwor- 
thiness of  the  inventory  is  affected  by  that  of  the  accounts. 
Every  phase  of  rate  control  based  on  cost  of  service  is  de- 
pendent upon  accurate  accounting. 

1  It  is  questionable  whether  it  would  not  even  be  better  to  restrict  cap- 
italization to  actual  value  in  the  case  of  consolidations  too,  though  many 
of  the  Utilities  Acts  do  not  do  so. 


44  FAIR  VALUE 

XIII.  Summary 

The  full  realization  of  the  widest  aims  of  utility  regula- 
tion, including  the  socialization  of  the  service  and  the  estab- 
lishment of  cheap  rates  to  develop  the  territory  and  raise  the 
standard  of  living,  is  impossible  under  private  ownership. 
The  purpose  of  a  regulatory  programme  based  on  private 
operation  is  primarily  the  protection  of  the  public  from  the 
private  interests  entrusted  with  the  conduct  of  the  service. 
The  aim  is  to  secure  adequate,  continuous,  non-discrimina- 
tory service  at  rates  which  will  attract  sufficient  capital 
and  yet  keep  the  price  of  service  near  the  cost.  The  public 
interest  is  supreme.  Private-property  rights  are  involved 
only  incidentally,  and  only  in  so  far  as  it  is  necessary  to  re- 
spect them  to  secure  the  necessary  capital  and  keep  within 
the  prohibitory  clauses  of  the  Federal  Constitution. 

The  many  phases  of  government  control  constitute  one 
unified  regulatory  programme,  every  part  of  which  is  de- 
pendent upon  the  successful  operation  of  every  other  part. 
Valuation  is  but  one  feature  of  public-utility  regulation. 
Both  its  form  and  aims  are  relative  to  the  part  of  the  general 
programme,  which  it  is  called  upon  to  carry  out.  Its  consid- 
eration apart  from  the  other  features  of  that  programme 
would  be  unintelligible. 


CHAPTER  III 

VALUATION  AND  REGULATION 

I.  Valuation  a  Judicial  Theory 

The  place  of  valuation  in  public-utility  regulatory  pro- 
grammes is  essentially  a  legal  question.  Valuation  theories 
have  been  created  wholly  by  Judicial  decision.  Economic 
forces  have  but  recently  been  permitted  to  influence  valua- 
tion principles.  The  present  doctrine  of  the  Federal  Supreme 
Court  as  to  "fair  value"  is  an  artificial  structure  of  piece- 
meal construction,  forming,  not  a  unified  whole  based  upon 
economic  principles,  but  a  conglomerate  mass  shaped  by 
the  varying  issues  presented  in  a  number  of  separate  cases. 
The  growth  has  been  gradual.  It  has  been  almost  haphaz- 
ard. The  court  decisions  have  not  been  wholly  consistent. 
Even  the  individual  holdings  of  the  several  members  of  the 
Supreme  Bench  have  lacked  unity.  No  definitely  stated  or 
clearly  analyzed  theory  has  been  developed.  Before  at- 
tempting to  collect  the  fundamental  principles  of  valuation 
and  analyze  them,  it  is  necessary,  therefore,  to  follow  the 
development  of  the  theory  through  the  long  line  of  deci- 
sions which  contain,  but  can  scarcely  be  said  to  state,  the 
law. 

II.  The  Granger  Cases 

In  the  Munn  Case1  the  Court  held  without  qualification 
that  the  State  legislative  power  may  regulate  rates  where 
the  public  has  an  interest  in  the  business.  The  issue  was  the 
constitutionality  of  a  maximum-rate  law.  The  State's  au- 
thority was  unhesitatingly  upheld.  Rate-making  was  looked 

1  94  U.S.  113,  24  L.  ed.  72.  See  also  Sinking-Fund  Cases,  99  U.S.  700, 
25  L.  ed.  496;  Spring  Valley  Waterworks  p.  Schottler,  110  U.S.  347. 
4  Sup.  Ct.  48, 24  L.  ed.  173. 


46  FAIR  VALUE 

upon  as  a  legitimate  safeguard  for  the  public  welfare.  Rate 
regulation  was  regarded  as  a  justifiable  condition  or  limita- 
tion upon  the  use  of  private  property  voluntarily  devoted 
to  a  public  use  for  private  gain.  The  claim  of  property 
rights  under  the  Fourteenth  Amendment,  which  has  since 
become  the  basis  of  judicial  review  and  a  limitation  upon 
the  State  police  power,  was  forcibly  advanced  by  the  util- 
ities, and  received  consideration.  The  Court  without  falter- 
ing, however,  denied  the  claim  with  unmistakable  empha- 
sis, saying: 

It  is  insisted,  however,  that  the  owner  of  property  is  entitled  to 
a  reasonable  compensation  for  its  use,  even  though  it  be  clothed 
with  a  public  interest,  and  that  what  is  reasonable  -is  a  judicial 
and  not  a  legislative  question. 

As  has  already  been  shown,  the  practice  has  been  otherwise.  In 
countries  where  the  common  law  prevails  it  has  been  customary 
from  time  immemorial  for  the  legislature  to  declare  what  shall  be  a 
reasonable  compensation  under  such  circumstances.  .  .  . 

Rights  of  property  which  have  been  created  by  the  common 
law  cannot  be  taken  away  without  due  process;  but  the  law  itself, 
as  a  rule  of  conduct,  may  be  changed  at  the  will,  or  even  at  the 
whim  of  the  legislature,  unless  prevented  by  constitutional  limita- 
tion. .  .  . 

We  know  that  this  is  a  power  which  may  be  abused,  but  that  is 
no  argument  against  its  existence.  For  -protection  against  abuses  by 
the  legislature  the  people  must  resort  to  the  polls,  not  the  courts.1 

The  dissenting  opinion  turned  squarely  upon  the  ques- 
tion of  property  rights  and  gave  to  the  Fourteenth  Amend- 
ment the  interpretation  that  has  since  been  adopted  to  pro- 
tect private  interest  at  the  expense  of  public  control.  The 
majority  opinion  was  clear-cut  and  met  the  question 
squarely.  The  Court  encountered  the  exercise  of  a  recog- 
nized legislative  power  in  a  recognized  field  for  a  purpose 
sanctioned  by  the  common  law.  The  rule,  so  often  reaf- 

1  "  Where  property  has  been  clothed  with  a  public  interest,  the  legisla- 
ture may  fix  a  limit  to  that  which  shall  in  law  be  reasonable  for  its  use. 
This  limit  binds  the  courts,  as  well  as  the  people.  If  it  has  been  improperly 
fixed,  the  legislature,  not  the  courts,  must  be  appealed  to  for  the  change." 
Peik  v.  Chicago  &  Nw.  Ry.  Co.,  94  U.S.  178. 


VALUATION  AND  REGULATION  47 

firmed  since  the  Munn  Case,  that  the  Court  will  not  in- 
quire into  the  expediency  of  the  exercise  of  a  legislative 
power  seemed  controlling.   The  Court  said: 

Of  the  propriety  of  legislative  interference  within  the  scope  of 
legislative  power,  the  legislature  is  the  exclusive  judge. 

This  repudiation  of  the  theory  of  judicial  review  pre- 
vented consideration  of  the  alleged  limitation  upon  the 
State's  police  power. 

The  extent  of  the  rate-making  power  arose  again  as  an 
issue  in  the  case  of  the  Chicago,  Burlington  and  Quincy 
Railroad  Company  v.  Iowa.1  In  petitioning  for  an  injunc- 
tion to  restrain  the  enforcement  of  the  State  maximum- 
rate  law  the  attorneys  for  the  railroad  contended  that  the 
act  violated  the  due-process  clause  of  the  Fourteenth 
Amendment,  advancing  the  argument  that  has  since  be- 
come the  controlling  one  in  valuation  cases.  The  argument 
was  rejected  by  implication.2 

The  Court  applied  the  strict  theory  of  regulative  con- 
trol stated  in  the  Munn  Case.  The  issue  was  construed  as 
the  protection  of  the  public  right  to  service  at  reasonable 
charges  from  the  rate-making  attacks  of  a  company  fully 
able  to  take  care  of  itself.  The  plea  of  that  company  for 
constitutional  protection  of  its  right  to  profit  from  the 
property  employed  in  the  public  service  was  subordinated 
to  the  plea  of  the  public  for  protection  of  its  rights  as  de- 
fined by  the  State  legislative  power. 

The  same  question  of  property  rights  was  advanced  in 
the  case  of  Tilley  v.  S.  F.  and  W.  Railway  Company  3  and 

1  94  U.S.  155. 

2  The  Court  said : "  It  was  within  the  power  of  the  company  to  call  upon 
the  legislature  to  fix  permanently  this  limit,  and  make  it  a  part  of  the  char- 
ter; and  if  it  was  refused,  to  abstain  from  building  the  road  and  establish- 
ing the  contemplated  business.  If  that  had  been  done,  the  charter  might 
have  presented  a  contract  against  future  legislative  interference.  But  it 
was  not,  and  the  company  invested  its  capital,  relying  upon  the  good 
faith  of  the  people  and  the  wisdom  and  impartiality  of  legislators  for  pro- 
tection against  wrong  under  the  form  of  legislative  regulation." 

3  5  Fed.  641. 


48  FAIR  VALUE 

valuation  was  suggested  as  the  test  in  applying  the  alleged 
constitutional  limitation,  but  the  Court  declined  to  con- 
sider it,  saying: 

The  question  whether  the  rates  prescribed  by  the  legislature 
either  directly  or  indirectly,  are  just  and  reasonable,  is  a  question 
which  the  legislature  may  determine  for  itself. 

So  long  as  the  Court  rejected  the  principle  of  judicial 
review  it  was  powerless  to  consider  the  question  of  reason- 
ableness. Valuation  and  the  other  tests  of  rate-making 
could  receive  no  consideration  in  the  decisions. 

III.  The  Commission  Cases 

The  question  came  up  again  nearly  a  decade  after  the 
decision  in  the  Munn  Case,  in  the  Railroad  Commission 
Cases,1  being  dragged  in  by  the  Court  by  way  of  dictum  in 
cases  brought  to  restrain  the  Missouri  Railroad  Commis- 
sion from  fixing  rates  on  the  ground  that  the  companies' 
charters  constituted  contracts  exempting  them  from  State 
rate  control.  The  Court  said: 

From  what  has  thus  been  said,  it  is  not  to  be  inferred  that  this 
power  of  limitation  or  regulation  is  itself  without  limit.  This 
power  to  regulate  is  not  a  power  to  destroy  and  limitation  is  not 
the  equivalent  of  confiscation.  Under  pretense  of  regulating  fares 
and  freight,  the  State  cannot  require  a  railroad  corporation  to 
carry  persons  or  property  without  reward;  neither  can  it  do  that 
which  in  law  amounts  to  taking  of  private  property  for  public  use 
without  just  compensation,  or  without  due  process  of  law.  What 
would  have  this  effect  we  need  not  now  say  because  no  tariff  has 
yet  been  fixed. 

Admittedly  the  question  was  not  in  issue,  and  the  dic- 
tum was  not  followed  out  in  the  decision. 

The  Court  did  not  attack  the  regulatory  power  of  the 
State,  but  suggested  for  the  first  time  a  limitation  on  that 
power.  No  intimation  was  given  of  the  nature  of  the  sug- 
gested limitation,  and  no  authority  cited  to  prove  its  exist- 

1  Stone  v.  Farmers'  Loan  &  Trust  Co.,  116  U.S.  307, 6  Sup.  Ct.  334. 


VALUATION  AND  REGULATION  49 

ence.  The  authority  to  regulate  rates  within  the  limits 
set  was  expressly  upheld. 

The  question  of  valuation  was  brought  directly  to  the 
Court's  attention  by  the  statute  in  question,  which  directed 
a  revision  of  tariffs  to  permit  a  "fair  and  just  return  on  the 
value  of  such  road,  its  appurtenances  and  equipment,"  but 
the  opinion  did  not  consider  the  question.  The  dissenting 
opinions  of  Justices  Field  and  Harlan,  however,  took  up  the 
subject  and  clearly  repudiated  valuation  as  a  limitation 
upon  rate-making. 

The  case,  in  view  of  the  strongly  worded  decisions  in  the 
Granger  Cases,  can  only  be  explained  by  the  fact  that  just 
at  this  time  a  sweeping  change  was  taking  place  in  the 
views  of  the  Supreme  Court.  The  Court,  because  it  is  re- 
quired to  apply  a  legal  system  developed  during  the  laissez- 
faire  period  which  unduly  emphasizes  individualistic  theo- 
ries and  the  protection  of  individual  rights,  has  not  been 
inclined  to  respond  to  the  reaction  from  the  laissez-faire 
doctrine.  The  growth  of  the  legal  concept  which  empha- 
sizes the  social  duties  and  responsibilities  attaching  to  the 
individual  and  to  private  property  has  been  slow.  The 
Granger  Cases  marked  the  awakening  to  the  change.  They 
met  with  strong  dissent.  A  change  in  the  makeup  of  the 
Court  strengthened  the  minority.  An  opportunity  to  limit 
the  regulatory  movement  and  establish  the  doctrine  of  ju- 
dicial review  was  soon  presented.  The  Fourteenth  Amend- 
ment, passed  as  a  political  war  measure  to  conserve  the 
fruits  of  victory  by  protecting  negro  rights  in  the  South, 
was  conceived  of  as  applicable  to  the  new  and  wholly  un- 
related subject  of  corporate  rights.  The  due-process  clause 
of  that  amendment  was  judicially  amended  to  make  it 
coextensive  with  the  limitation  imposed  upon  the  Federal 
Government  by  the  Fifth  Amendment.  Influenced  by  the 
new  idea,  the  Court  threw  in  the  dictum  of  the  Commission 
Cases,  that  the  legislative  power  of  regulation  is  subject  to 
judicial  limitation,  and  hastened  on  to  declare  a  corporation 


50  FAIR  VALUE 

a  person  within  the  meaning  of  the  amendment.  The  open- 
ing thus  offered  for  Federal  judicial  smothering  of  State 
regulatory  activity  was  instantly  taken  advantage  of  by 
corporations  crowding  to  seek  safety  from  the  excessive 
rate  legislation  brought  on  by  early  corporate  evils.  Under 
this  pressure  the  Court,  in  direct  reversal  of  the  Granger 
Cases,  extended  the  meaning  of  "due  process"  to  include 
"taking  property  without  just  compensation,"  and  ex- 
tended its  review  jurisdiction  to  include  the  State  police 
power. 

The  majority  opinion  in  the  Commission  Cases  suggests 
for  the  first  time  that  legislative  rate  control  is  limited  by 
the  confiscation  clause.  "Due  process"  receives  a  new  con- 
struction based  upon  taking  private  property  without  com- 
pensation. The  language  of  the  decision  is  therefore  de- 
serving of  note.  The  underlying  thought  is  that  the  State 
cannot  require  a  railroad  corporation  to  carry  persons  or 
property  without  reward.  The  reasoning  is  unquestionably 
sound.  But  in  groping  for  a  basis  for  the  rule  the  Court 
seems  to  have  been  led  astray  by  the  subtle  suggestion  of 
counsel  for  the  road,  and  the  opinion  continues,  "neither 
can  it  do  that  which  in  law  amounts  to  taking  of  private 
Y  property  for  a  public  use  without  just  compensation,  or 
due  process  of  law."  This  too  is  a  correct  statement  of  an  ab- 
stract legal  proposition,  but  the  Court  offers  no  valid  ex- 
cuse for  coupling  it  with  aught  that  has  preceded  either  by 
way  of  premise  or  conclusion.  There  is  no  attempt  to  show 
that  rate-making  can  or  does  enter  the  field  of  confiscation. 
The  Court,  after  volunteering  the  information,  therefore 
abandons  the  point  with  the  statement  that  the  question 
was  not  before  it  anyway. 

The  opinion  plunges  the  Court  into  the  midst  of  a  new 

phase  of  the  old  Jeffersonian  dispute  as  to  the  right  of  the 

Court  to  declare  a  State  law  unconstitutional,  started  by 

the  decision  in  Marbury  v.  Madison.1  A  decision  upholding 

1  1  Cranch,  137,  2  L.  ed.  60. 


VALUATION  AND  REGULATION  51 

the  Court's  power  was  inevitable.  The  logical,  economic, 
and  legal  soundness  of  the  decision,  where  the  purpose  of 
private  property  and  the  aims  of  regulation  are  considered, 
is  not  so  apparent.  The  exercise  of  the  police  power  par- 
takes of  the  nature  of  a  legislative  declaration  of  what  the 
rights  of  private  property  within  the  State  shall  be.  It  de- 
fines private  property.  The  function  is  purely  legislative.  It 
is  one  inherent  in  the  State.  The  basis  of  the  authority  of 
the  Federal  judiciary  to  interfere  remains  to  be  clearly 
pointed  out.  It  certainly  was  not  definitely  stated  in  the 
Fourteenth  Amendment.  It  has  not  been  established  to  the 
satisfaction  of  the  average  mind  by  the  question-begging 
reference  to  the  law  of  the  land. 

IV.  Dow  v.  Beidelman 

In  Dow  v.  Beidelman1  the  railroads  again  raised  the 
question  of  the  constitutional  limitation  upon  the  rate- 
making  power  of  the  State,  in  a  suit  to  test  the  validity  of 
an  Arkansas  statute  reducing  passenger  fares.  The  Court 
quoted  the  dictum  of  the  Commission  Cases  without  com- 
ment, but  went  on  to  add: 

The  plaintiffs  in  error  .  .  .  argue  .  .  .  that  with  the  same  traffic 
that  their  road  has  now,  and  charging  for  transportation  at  the 
rate  of  three  cents  per  mile,  the  net  yearly  income  will  pay  less 
than  If  per  cent  on  the  original  cost  of  the  road,  and  only  a  little 
more  than  2  per  cent  on  the  amount  of  its  bonded  debt.  But  there 
is  no  evidence  whatever  as  to  how  much  money  the  bonds  cost,  or 
as  to  the  amount  of  the  capital  stock  of  the  corporation  as  reorgan- 
ized, or  as  to  the  sum  paid  for  the  road  by  that  corporation  or  its 
trustees.  It  certainly  cannot  be  presumed  that  the  price  paid  at  the 
sale  under  the  decree  of  foreclosure  equaled  the  original  cost  of  the 
road,  or  the  amount  of  outstanding  bonded  debt.  Without  any 
proof  of  the  sum  invested  by  the  reorganized  corporation  or  its 
trustees,  the  Court  has  no  means,  if  it  would  under  any  circumstances 
have  the  power,  of  determining  that  the  rate  of  three  cents  a  mile,  fixed 
by  the  legislature  is  unreasonable.  Still  less  does  it  appear  that  there 
has  been  any  such  confiscation  as  amounts  to  a  taking  of  property 
without  due  process  of  law. 

1  125  U.S.  680,  8  Sup.  Ct.  1028. 


52  FAIR  VALUE 

The  attempt  is  made  for  the  first  time  to  indicate  the 
nature  of  the  limitation  on  the  State's  rate-making  power. 

The  value  of  the  property  is  recognized  as  a  feasible 
basis  for  rate-making.  The  test  of  value  suggested  is  the  sum 
actually  invested.  Capitalization  and  the  value  of  outstand- 
ing securities  are  rejected  as  a  basis  for  valuation.  But 
the  Court  is  still  doubtful  of  its  power  to  apply  the  test. 
The  dictum  of  the  Commission  Cases  is  not  fully  accepted. 
The  Court  is  unwilling  to  take  a  step  which  would  in  effect 
change  rate-making  from  a  legislative  to  a  judicial  function. 
The  purpose  of  private  property  and  the  aims  of  regulation 
have  re-occurred  to  the  judicial  mind.  The  question  of  pub- 
lic interest  is  still  paramount,  that  of  private  property  sub- 
ordinate. 

The  issue  arose  next  a  few  months  later  in  the  case  of  the 
Georgia  Railroad  and  Banking  Company  v.  Smith,1  in 
which  the  roads  again  advanced  the  claim  for  exemption 
based  on  a  charter  contract.  The  Court  accepted  and  re- 
stated the  doctrine  of  the  Commission  Cases  dictum  with- 
out analysis  —  quoting  as  its  authority  that  case  and  Dow 
v.  Beidelman. 

But  here  as  in  the  Commission  Cases  the  statement  was 
but  dictum,  as  the  only  issue  really  before  the  Court  was 
the  claim  for  exemption  from  all  regulation  by  reason  of  the 
alleged  charter  contract. 

The  Court  shows  the  confusion  and  uncertainty  under 
which  it  labored  by  adding  the  apparently  inconsistent  but 
judicially  sound  statement  that: 

When  such  use  [publicl  exists  the  business  becomes  subject  to 
legislative  control  in  all  respects  necessary  to  protect  the  public 
against  danger,  injustice,  and  oppression. 

In  Chicago,  Milwaukee  and  St.  Paul  Railway  Company 
v.  Minnesota  2  the  question  of  judicial  review  was  squarely 
presented  to  the  Court  for  the  first  time,  but  the  case  arose 

1  128  U.S.  174,  9  Sup.  Ct.  47,  32  L.  ed.  377. 

2  134  U.S.  418  and  458, 10  Sup.  Ct.  462  (1st  Minnesota  Rate  Case). 


VALUATION  AND  REGULATION  53 

in  a  somewhat  different  manner  from  those  previously  con- 
sidered. The  State  of  Minnesota  passed  a  law  authorizing 
the  Railroad  and  Warehouse  Commission  to  prescribe  rea- 
sonable rates.  The  State  Supreme  Court  construed  the  act, 
in  spite  of  its  apparently  contrary  intent,  as  conferring 
final  authority  upon  the  Commission.  And  the  Federal  Su- 
preme Court  held  this  denial  of  judicial  review  a  violation 
of  the  due-process  clause,  saying: 

The  question  of  the  reasonableness  of  a  rate  of  charge  for  trans- 
portation by  a  railroad  company,  involving,  as  it  does,  the  ele- 
ment of  reasonableness  both  as  regards  the  company  and  as  re- 
gards the  public,  is  eminently  a  question  for  judicial  investigation 
requiring  due  process  of  law  for  its  determination.  ...  If  the 
company  is  deprived  of  the  power  of  charging  reasonable  rates  for 
the  use  of  its  property,  and  such  deprivation  takes  place  in  the 
absence  of  an  investigation  by  judicial  machinery,  it  is  deprived  of 
the  lawful  use  of  its  property,  and  thus,  in  substance  and  effect,  of 
the  property  itself,  without  due  process  of  law,  and  in  violation  of 
the  Constitution  of  the  United  States,  and  in  so  far  as  it  is  thus 
deprived,  while  other  persons  are  permitted  to  receive  reasonable 
profits  upon  their  invested  capital,  the  company  is  deprived  of  the 
equal  protection  of  the  laws. 

The  policy  of  judicial  review  was  definitely  accepted, 
though  not  the  basis  upon  which  it  rests.  The  dictum  of  the 
Commission  Cases  became  law  without  citation  of  authority 
or  statement  of  reason,  and  clearly  without  the  formula- 
tion of  any  definite  basis  upon  which  the  review  should  be 
conducted  or  any  rules  as  to  when  it  should  be  undertaken. 
That  portion  of  the  decisions  in  the  Granger  Cases  which 
conferred  power  upon,  or  recognized  authority  in,  the  leg- 
islature to  regulate  utilities  and  fix  rates  binding  even 
upon  the  courts  was  finally  reversed. 

The  whole  stress  of  the  decision  was  placed  upon  the  ab- 
sence of  notice  and  investigation  in  the  rate-making,  upon 
the  strict  due-process  clause  as  that  term  had  been  defined 
up  to  this  time.  Due  process  still  had  not  been  authorita- 
tively extended  to  include  the  requirement  of  just  compen 


54  FAIR  VALUE 

sation  when  "taking  private  property  for  public  use."  The 
basis  of  valuation  was  yet  to  be  adopted. 

The  question  arose  next  in  Chicago  and  Grand  Trunk 
Railway  Company  v.  Wellman,1  and  in  Budd  v.  New  York,2 
decided  on  the  same  day.  In  the  latter  case  after  reviewing 
the  entire  field  of  decisions  both  federal  and  state  the  Court 
concludes: 

In  the  case  before  us,  the  records  do  not  show  that  the  charges 
are  unreasonable,  or  that  property  has  been  taken  without  due 
process  of  law,  or  that  there  has  been  any  denial  of  the  equal  pro- 
tection of  the  laws;  even  if  under  any  circumstances  we  could  deter- 
mine that  the  maximum  rate  fixed  by  the  legislature  was  unreasonable. 

Even  yet  the  Court  is  feeling  its  way,  is  in  fact  doubtful 
of  its  ability  to  question  the  reasonableness  of  the  rate. 
Corporation  persistency  has  not  succeeded  in  making  regu- 
lation and  the  public  interest  subordinate  to  the  financial 
interest  of  the  investors.  Regulation  is  still  regarded  as  a 
proper  governmental  function,  to  be  exercised  by  the  leg- 
islature to  any  extent  it  deems  necessary  to  further  the 
public  welfare.  Judicial  legislation  defining  the  status  of  pri- 
vate property  within  the  State  is  avoided.  But  there  is  con- 
fusion in  the  decisions.  No  definite  policy  has  been  worked 
out.  The  trouble-breeding  dictum  of  the  Commission  Cases 
is  neither  repudiated  nor  accepted.  The  decision  in  the 
Granger  Cases  is  neither  reversed  nor  accepted  in  toto.  The 
Court  see-saws  first  toward  legislative  regulation  and  pub- 
lic welfare,  then  toward  judicial  interference  and  private 
interest. 

The  facts  in  Budd  v.  New  York  differed  from  those  in  the 
Minnesota  Rate  Case.  In  the  former  the  rate-making  power 
was  exercised  directly  by  the  legislature.  In  the  latter  it  was 
exercised  by  a  commission.  If  the  Court  was  willing  to  set 
any  limit  at  all  on  State  rate-making  along  the  lines  indi- 
cated in  the  first  Minnesota  Rate  Case,  it  now  indicated 

1  143  U.S.  339,  12  Sup.  Ct.  400.  2  143  U.S.  517,  12  Sup.  Ct.  468. 


VALUATION  AND  REGULATION  55 

that  it  was  unwilling  to  extend  that  limitation  to  rates 
directly  fixed  by  the  legislature. 

Two  years  later  the  jumble  left  by  the  Budd  decision  was 
cleared  up  to  a  large  extent  by  the  decision  in  the  Reagan 
Cases.1 

V.  Reagan  v.  The  Farmers'  Loan  and  Trust  Company 

In  Reagan  v.  The  Farmers'  Loan  and  Trust  Company, 
which  rose  by  way  of  injunction  issued  to  restrain  the  Texas 
Railroad  Commission  from  enforcing  rates  it  had  fixed,  the 
Court  for  the  first  time  treats  clearly  the  question  of  legis- 
lative regulation  of  private  property  employed  in  a  public 
undertaking.  After  a  review  of  the  situation  the  decision 
says: 

These  cases  all  support  the  proposition  that  while  it  is  not  the 
province  of  courts  to  enter  upon  the  merely  administrative  duty 
of  framing  a  tariff  of  rates  for  carriage,  it  is  within  the  scope  of 
judicial  power,  and  a  part  of  judicial  duty,  to  restrain  anything 
which,  in  the  form  of  a  regulation  of  rates,  operates  to  deny  to  the 
owners  of  property  invested  in  the  business  of  transportation  that 
equal  protection  which  is  the  constitutional  right  of  all  owners  of 
other  property.  There  is  nothing  new  or  strange  in  this.  It  has 
always  been  a  part  of  the  judicial  function  to  determine  whether 
the  act  of  one  party  (whether  that  party  be  a  single  individual,  an 
organized  body,  or  the  public  as  a  whole)  operates  to  divest  the 
other  party  of  any  rights  of  person  or  property.  In  every  constitu- 
tion is  the  guaranty  against  the  taking  of  private  property  for 
public  purposes  without  just  compensation.  The  equal  protection 
of  tbe  laws,  which,  by  the  Fourteenth  Amendment,  no  State  can 
deny  to  the  individual,  forbids  legislation,  in  whatever  form  it  may 
be  enacted,  by  which  the  property  of  one  individual  is,  without 
compensation,  wrested  from  him  for  the  benefit  of  another,  or  of 
the  public.2 

1  Reagan  v.  The  Farmers'  Loan  &  Trust  Co.,  154  U.S.  362, 14  Sup.  Ct. 
180, 38  L.  ed.  1014;  Reagan  v.  The  Mercantile  Trust  Co.,  154  U.S.  413;  Rea- 
gan v.  The  Mercantile  Trust  Co.,  154  U.S.  418;  Reagan  v.  The  Farmers' 
Loan  &  Trust  Co.,  154  U.S.  420. 

2  See  also  Railway  Co.  v.  Gill,  156  U.S.  649,  15  Sup.  Ct.  484,  39  L.  ed. 
567.  The  rate  question  arose  too  in  Covington  &  L.  Turnpike  Road  Co.  v. 


\ 


56  1  FAIR  VALUE 

The  Court  does  not  question  the  legislature's  right  to 
protect  the  public  by  fixing  a  maximum  rate,  but  it  reaffirms 
without  limitation  the  Court's  right  to  review  rates  and 
clearly  establishes  a  minimum  below  which  the  legislature 
cannot  fix  rates  and  enforce  service.  With  equal  clearness 
the  Court  subordinates  the  utility's  right  to  a  profit  to  the 
right  of  the  public  to  receive  service  at  reasonable  rates, 
saying: 

It  is  unnecessary  to  decide,  and  we  do  not  wish  to  be  understood 
as  laying  down  an  absolute  rule,  that  in  every  case  a  failure  to 
produce  some  profit  to  those  who  have  invested  their  money  in 
the  building  of  a  road  is  conclusive  that  the  tariff  is  unjust  and  un- 
reasonable. And  yet  justice  demands  that  every  one  should  re- 
ceive some  compensation  for  the  use  of  his  money  or  property  if 
it  be  possible,  without  prejudice  to  the  rights  of  others.  There 
may  be  circumstances  which  would  justify  such  a  tariff;  there 
may  have  been  extravagance  and  needless  expenditures  of  money, 
there  may  be  waste  in  the  management  of  the  road;  enormous 
salaries;  unjust  discrimination  as  between  individual  shippers, 
resulting  in  general  loss.  The  construction  may  have  been  at  a 
time  when  material  and  labor  were  at  the  highest  price,  so  that 
the  actual  cost  far  exceeds  the  present  value.  The  road  may  have 
been  unwisely  built,  in  localities  where  there  is  not  sufficient 
business  to  sustain  a  road.  Doubtless,  too,  there  are  many  other 
matters  affecting  the  rights  of  the  community  in  which  the  road 
is  built,  as  well  as  the  rights  of  those  who  have  built  the  road. 

Value  of  the  property  is  again  recognized  as  a  feasible 
basis  for  rate  regulation,  and  as  in  Dow  v.  Beidelman  it  is 
the  actual  cost  or  investment  which  it  is  assumed  will  be 
the  controlling  figure.  In  the  principal  case,  however,  a  lim- 
itation is  placed  upon  actual  cost.  That  limitation  is  refer- 
ence to  "present  value,"  the  concept  which  has  brought 
more  confusion  into  valuation  cases  than  all  others  com- 
bined. And  this  limitation  is  imposed  not  to  protect  the  util- 
ity, but  because  actual  cost  may  have  been  unjustifiably 
high. 

Sandford,  164  U.S.  578, 17  Sup.  Ct.  198;  and  Chicago,  B.  &  Q.  R.R.  Co. 
v.  Chicago,  166  U.S.  226,  17  Sup.  Ct.  571,  but  no  additional  ruling  of  im- 
portance was  made. 


VALUATION  AND  REGULATION  57 

The  treatment  of  the  problem  is  clear,  but  there  is  no 
definite  theory  upon  which  the  Court  proceeds.  Its  state- 
ments considered  as  independent,  abstract  legal  proposi- 
tions are  indisputable,  but  considered  as  a  whole  they  ap- 
pear conflicting  and  ambiguous.  The  gist  of  the  holding 
seems  to  be  that  rates  cannot  be  fixed  at  a  figure  which  is 
below  the  cost  of  production  when  proper  methods  are  used 
and  only  such  investment  is  made  as  is  necessary  for  the 
service  rendered.  In  other  words,  it  is  not  the  actual  cost  of 
production,  but  the  theoretical  reasonable  cost  that  is  in 
question.  The  Court  for  the  first  time  places  valuation  on  a 
truly  economic  basis.  The  economies  of  monopoly  are  per- 
mitted, but  monopoly  price  is  prohibited.  The  waste  of 
competition  is  banished,  but  its  benefits  arbitrarily  re- 
tained by  fixing  prices  at  approximately  the  cost  of  produc- 
tion or  competitive  figure.  The  complete  advantage  of  rate 
regulation  is  gained  by  keeping  the  cost  of  production  be- 
low the  competitive  figure.  The  disadvantage  of  regulation 
is  eliminated  by  basing  it  on  the  same  economic  principle 
which  would  have  governed  had  natural  competition  ex- 
isted. The  public  secures  the  advantage  of  lower  rates,  the 
utility  those  from  greater  economy. 

One  point  remains  unsettled,  i.e.,  the  power  of  the  State 
to  compel  service  at  a  rate  below  the  cost  of  service.  Where 
that  cost  is  greater  than  the  theoretical  or  reasonable  cost 
the  issue  is  decided  in  favor  of  the  public.  The  case  does  not 
involve  a  situation  in  which  the  worth  of  the  service  to  the 
community  is  less  than  the  reasonable  cost  of  service. 

VI.  The  Growth  of  the  Confiscation  Analogy 

The  fallacy  in  the  line  of  argument  in  the  cases  thus  far 
discussed  first  bore  fruit  in  the  Reagan  Case  where  Jus- 
tice Brewer  intimated  the  propriety  of  reasoning  in  rate 
cases  by  analogy  with  condemnation  cases,  saying: 

If  the  State  were  to  condemn  the  railroads,  is  there  any  doubt 
that  constitutional  provisions  would  require  the  payment  to  the 


58  FAIR  VALUE 

corporation  of  just  compensation,  —  that  compensation  being 
the  value  of  the  property  as  it  stood  in  the  markets  of  the  world 
and  not  as  prescribed  by  an  act  of  the  legislature?  Is  it  any  less  a 
departure  from  the  obligations  of  justice  to  seek  to  take  not  the 
title,  but  the  use  for  the  public  benefit  at  less  than  its  market 
value? 

In  Ames.  v.  Union  Pacific  Railway  Company x  the  anal- 
ogy was  stated  again  without,  however,  definitely  holding 
that  the  two  situations  were  identical. 

Such  was  the  status  of  the  law  when  the  epoch-making 
decision  of  Smyth  v.  Ames  2  was  rendered.  The  power  of  the 
State  legislature  to  regulate  was  fully  established,  but 
within  certain  limits  only  when  the  power  was  directed  to- 
ward rate-making.  Rates  could  not  be  forced  below  a  figure 
which  would  render  a  fair  return  upon  the  "fair  value"  of 
the  property.  What  constituted  a  fair  return  or  fair  value 
remained  unsettled.  The  question  of  valuation  had  been 
brought  up  in  Covington  and  Lexington  Turnpike  Road  v. 
Sandford,  indirectly  in  the  Reagan  Case,  and  had  been 
hinted  at  in  Dow  v.  Beidelman,  but  it  had  not  been  defi- 
nitely adopted  by  the  Supreme  Court. 

The  lower  courts  had  discussed  the  question  more  thor- 
oughly. In  Ames  v.  Union  Pacific  Railway,3  the  Court 
warned  against  unreasonable  investment  and  suggested 
the  condemnation  analogy.  Two  years  later,  in  San  Diego 
Land  and  Town  Company  v.  National  City,4  Judge  Ross 

1  64  Fed.  165. 

2  169  U.S.  466.  18  Sup.  Ct.  418,  42  L.  ed.  819;  Justice  Brewer  said: 
"Property  invested  in  railroads  is  as  much  protected  from  appropriation 
as  any  other.  If  taken  for  public  uses,  its  value  must  be  paid  for.  Consti- 
tutional guarantees  to  this  extent  are  explicit.  .  .  .  The  value  of  the  prop- 
erty cannot  be  destroyed  by  legislation.  .  .  .  The  protection  of  property 
implies  the  protection  of  its  value.  ...  If  the  public  was  seeking  to  take 
title  to  the  railroad  by  condemnation,  the  present  value  is  that  which 
it  would  have  to  pay.  In  like  manner,  it  may  be  argued  that,  when  the 
legislature  assumes  the  right  to  reduce  rates,  the  rates  so  reduced  cannot 
be  adjudged  unreasonable  if  under  them  there  is  earned  a  fair  interest  on 
the  actual  value  of  the  property." 

3  64  Fed.  165  (1894). 

4  74  Fed.  79  (189G).  See  also  San  Diego  Land  &  Town  Co.  v.  Jasper,  110 
Fed.  702  (1901) ;  Cotting  v.  Kansas  City  Stock  Yards  Co.,  82  Fed.  850. 


VALUATION  AND  REGULATION  59 

held  that  as  cost  might  be  excessive,  present  value,  deter- 
mined with  "due  regard  to  the  right  of  the  public,"  must  be 
controlling. 

VII.  Smyth  v.  Ames 

In  Smyth  v.  Ames,1  a  suit  brought  to  test  the  constitu- 
tionality of  the  Nebraska  maximum-rate  law,  the  Court 
finally  definitely  settled  its  right  to  test  the  reasonableness 
of  rate  regulation,  saying: 

The  idea  that  any  legislature,  State  or  Federal,  can  conclusively 
determine  for  the  people  and  for  the  courts  that  what  it  enacts  in 
the  form  of  law,  or  what  it  authorizes  its  agents  to  do,  is  consist- 
ent with  the  fundamental  law,  is  in  opposition  to  the  theory  of  our 
institutions.  The  duty  rests  upon  all  courts,  Federal  and  State, 
when  their  jurisdiction  is  properly  invoked  to  see  to  it  that  no 
right  secured  by  the  supreme  law  of  the  land  is  impaired  or  de- 
stroyed by  legislation. 

The  Court  here  defines  its  jurisdiction  and  for  the  first 
time  undertakes  to  state  a  basis  for  judicial  review.  The 
Court  is  not  concerned  with  rate-making  as  such,  nor  di- 
rectly with  reasonableness  of  rates.  It  is  only  the  constitu- 
tional guarantees  which  it  must  consider.  It  is  only  when  a 
rate  violates  one  of  these  guarantees  that  it  can  be  brought 
before  the  Court.  The  expediency  of  the  rate  is  not  in  issue. 
The  question  is,  Has  the  constitutional  limitation  been 
violated?  —  not,  Is  the  regulation  reasonable?  The  former 
is  a  judicial,  the  latter  a  legislative  question.  The  two  must 
not  be  confused.  The  common-law  limitation  of  reason- 
ableness applies  as  a  legal  check  upon  rate-making  by  the 
utility,  but  not  upon  rate-making  by  the  State. 

Failure  to  keep  this  distinction  in  mind  and  unwilling- 
ness to  admit  that  it  has  been  made  are  responsible  for 
much  of  the  confusion  in  valuation.  Rate-making  is  a  leg- 
islative power.  The  question  of  reasonableness  is  a  legisla- 
tive one.  The  determination  of  what  rights  shall  constitute 

1  169  U.S.  466,  18  Sup.  Ct.  418,  42  L.  ed.  819. 


60  FAIR  VALUE 

private  property  at  a  given  time  is  for  the  legislature.1  But 
the  determination  of  what  amounts  to  a  taking  of  private 
property  for  a  public  purpose,  and  what  a  restriction  of 
property  without  actual  taking,  is  a  judicial  question.  The 
case  leaves  the  opportunity  still  open  for  legislative  dis- 
cretion, and  legislative  action  to  protect  the  public  welfare. 
The  Court  next  turns  its  attention  to  the  purpose  of  reg- 
ulation and  decides  beyond  question  that  the  protection  of 
the  public  interest  is  the  paramount  issue  in  rate  regula- 
tion, saying: 

If  a  railroad  corporation  has  bonded  its  property  for  an  amount 
that  exceeds  its  fair  value,  or  if  its  capitalization  is  largely  ficti- 
tious, it  may  not  impose  upon  the  public  the  burden  of  such  in- 
creased rates  as  may  be  required  for  the  purpose  of  realizing  prof- 
its upon  such  excessive  valuation  or  fictitious  capitalization.  .  .  . 
What  was  said  in  Turnpike  Co.  v.  Sandford,  164  U.S.  578,  596,  is 
pertinent.  ...  It  cannot  be  said  that  a  corporation  is  entitled  as 
of  right,  and  without  reference  to  the  interests  of  the  public,  to 
realize  a  given  per  cent  upon  its  capital  stock.  When  the  question 
arises  whether  the  legislature  has  exceeded  its  constitutional 
power  in  prescribing  rates  to  be  charged  by  a  corporation  control- 
ling a  public  highway,  stockholders  are  not  the  only  persons  whose 
rights  or  interests  are  to  be  considered.  The  rights  of  the  public  are 
not  to  be  ignored.  It  is  alleged  here  that  the  rates  prescribed  are  un- 
reasonable and  unjust  to  the  company  and  its  stockholders.  But 
that  involves  an  inquiry  as  to  what  is  reasonable  and  just  for  the 
public.  .  .  .  The  public  cannot  be  subjected  to  unreasonable  rates  in 
order  simply  that  stockholders  may  earn  dividends.  .  .  .  If  the  cor- 
poration cannot  maintain  such  a  highway  and  earn  dividends  for 
stockholders,  it  is  a  misfortune  for  it  and  them  which  tlie  Constitu- 
tion does  not  require  to  be  remedied  by  imposing  unjust  burdens 
upon  the  public.2 

1  The  legislature  may  limit  the  rights  by  destruction  of  unit  rights 
through  the  exercise  of  the  State  police  power. 

2  It  was  held  in  Chicago,  etc.,  R.R.  Co.  v.  Dey,  35  Fed.  866,  that  the  in- 
terest of  mortgage  bondholders  is  an  element  to  be  considered  and  that  if 
the  rate  fixed  prevents  interest  being  paid  on  the  mortgage  debt  the  en- 
forcement of  the  schedule  amounts  to  confiscation.  It  is  suggested  that  the 
mortgage-holder  stands  in  no  better  position  than  the  stockholder.  He  has 
risktd  his  funds  in  the  undertaking.  If  it  was  poorly  conceived  or  badly 


VALUATION  AND  REGULATION  61 

Having  quoted  with  approval  this  decision  that  the  in- 
terests of  the  public  are  paramount  to  the  property  interest 
of  the  utility  the  Court  proceeds  to  point  out  which  of  those 
property  rights  cannot  be  taken  without  compensation, 
prefacing  its  remarks  with  a  further  guarantee  of  public 
interest,  thus: 

It  cannot  be  assumed  that  any  railroad  corporation,  accepting 
franchises,  rights,  and  privileges  at  the  hands  of  the  public,  ever 
supposed  that  it  acquired,  or  that  it  was  intended  to  grant  to  it, 
the  power  to  construct  and  maintain  a  public  highway  simply  for 
its  benefit,  without  regard  to  the  rights  of  the  public.  But  it  is 
equally  true  that  the  corporation  performing  such  public  serv- 
ices, and  the  people  financially  interested  in  its  business  and 
affairs,  have  rights  that  may  not  be  invaded  by  legislative  enact- 
ment in  disregard  of  the  fundamental  guaranties  for  the  protec- 
tion of  property.  The  corporation  may  not  be  required  to  use  its 
property  for  the  benefit  of  the  public  without  receiving  just  com- 
pensation for  the  services  rendered  by  it. 

The  Court  has  set  a  minimum  limit  on  rate-making  — 
the  theoretical  cost  of  producing  the  service  plus  a  return. 
The  actual  cost  of  production  is  immaterial. 

The  Court  proceeds  to  define  this  minimum  limit  with 
more  exactness,  thus: 

The  utmost  that  any  corporation  operating  a  public  highway 
can  rightfully  demand  at  the  hands  of  the  legislature,  when  exer- 
cising its  general  powers,  is  that  it  receive  what,  under  all  the  cir- 
cumstances, is  such  compensation  for  the  use  of  its  property  as 
will  be  just  both  to  it  and  to  the  public. 

The  market  value  of  outstanding  securities  and  the  exist- 
ing capitalization  of  the  utility  were  rejected  earlier  in  the 
opinion,  as  unjust  to  the  public.  What  would  be  just  re- 
mains undecided. 

The  contention  of  the  State  was  that  any  legislative- 
made  rate  schedule,  providing  necessary  operating  ex- 
penses and  a  sum  in  addition  thereto,  would  be  reasonable, 

managed,  the  consumer  who  exercised  no  judgment  in  making  the  invest- 
ment cannot  be  required  to  make  good  the  loss  from  the  bondholder's  own 
folly. 


62  FAIR  VALUE 

the  amount  of  the  additional  sum  being  purely  a  legislative 
question  not  open  to  judicial  review.  The  roads  contended 
that  the  schedule  must  provide  a  fair  profit  on  the  entire 
capitalization,  watered  and  real.  The  Court  took  a  stand 
midway  between  these  views,  saying: 

We  hold,  however,  that  the  basis  of  all  calculations  as  to  the 
reasonableness  of  rates  to  be  charged  by  a  corporation  maintain- 
ing a  highway  under  legislative  sanction  must  be  the  fair  value  of 
the  property  being  used  by  it  for  the  convenience  of  the  public. 
And  in  order  to  ascertain  that  value,  the  original  cost  of  construc- 
tion, the  amount  expended  in  permanent  improvements,  the 
amount  and  market  value  of  its  bonds  and  stock,  the  present 
as  compared  with  the  original  cost  of  construction,  the  probable 
earning  capacity  of  the  property  under  particular  rates  pre- 
scribed by  statute,  and  the  sum  required  to  meet  operating  ex- 
penses, are  all  matters  for  consideration,  and  are  to  be  given 
such  weight  as  may  be  just  and  right  in  each  case.  We  do  not 
say  that  there  may  not  be  other  matters  to  be  regarded  in  estimat- 
ing the  value  of  the  property.  What  the  company  is  entitled  to 
ask  is  a  fair  return  upon  the  value  of  that  which  it  employs  for  the 
public  convenience.  On  the  other  hand,  what  the  public  is  en- 
titled to  demand  is  that  no  more  be  exacted  from  it  for  the  use 
of  a  public  highway  than  the  services  rendered  by  it  are  reason- 
ably worth. 

Thus  the  valuation  test  of  the  constitutionality  of  State 
legislative  rates,  hinted  at  in  previous  decisions,  is  fully  es- 
tablished, by  the  Very  justice  who  repudiated  it  in  his  dis- 
senting opinion  in  the  Commission  Cases. 

Valuation  is  accepted  as  a  substitute  for  the  analogy 
with  condemnation  cases,  which  Justice  Brewer  suggested, 
and  to  which  Justice  Harlan  makes  no  reference.  There  is 
no  intimation  that  the  valuation  here  suggested  should  be 
the  same  as  that  in  condemnation  proceedings.  The  ele- 
ments of  value  in  that  class  of  cases  had  been  fully  stated 
by  the  courts.  That  Justice  Harlan  considered  a  definite 
statement  of  the  elements  of  value  for  rate-making  pur- 
poses necessary,  and  did  not  fashion  that  statement  on  con- 
demnation lines,  indicates  that  he  did  not  consider  the  two 


VALUATION  AND  REGULATION  63 

analogous.  That  he  included  in  that  statement  elements 
never  considered  as  value  in  condemnation  cases  leaves 
little  room  to  doubt  that  the  Court  rejected  the  condem- 
nation theory. 

VIII.  The  Condemnation  Theory 

It  may  not  be  out  of  place  to  digress  at  this  point  and 
consider  that  theory.  It  has  acquired  undeserved  promi- 
nence because  it  works  emphatically  to  the  benefit  of  the 
utilities,  and  because  writers  on  valuation  have  asserted 
without  careful  analysis  that  the  valuation  test  of  the 
reasonableness  of  rates  had  its  origin  in  the  condemnation 
analogy.  The  analogy  has  never  been  definitely  accepted  by 
the  Supreme  Court.  The  lower  courts,  however,  have  quali- 
fiedly  stated  the  relationship  *  in  several  cases,  and  fre- 
quently considered  the  analogy  without  definitely  stating 
it.2  But  a  preponderance  of  the  decisions,  even  in  the  lower 
courts,  have  flatly  rejected  the  theory  and  clearly  pointed 
out  inconsistencies  in  valuing  public-service  property  for 
rate  purposes  according  to  the  standards  set  for  condemna- 
tion cases.3 

*  In  Spring  Valley  Water  Co.  v.  City  and  County  of  San 
Francisco,4  the  Court  stated  that: 

1  Spring  Valley  Water  Works  v.  San  Francisco,  124  Fed.  574;  Kings 
County  Lighting  Co.  v.  Willcox,  156  App.  Div.  N.Y.  603;  see  also  San 
Diego  Water  Co.  v.  San  Diego,  118  Cal.  556. 

2  Oshkosh  Water  Works  Co.  v.  Railroad  Comm.  of  Wisconsin,  152  N. 
W.  859;  P.U.R.  1915-D-336;  State  ex  rel.  Oregon  R.  &  Navigation  Co.  v. 
Clausen,  116  PaciBc  (Wash.)  7,  dictum;  State  ex  rel.  Bee  Building  Co.  v. 
Savage,  65  Neb.  714,  91  N.  W.  (Neb.)  716,  dictum;  etc. 

3  Pub.  Serv.  Gas  Co.  v.  Bd.  of  Pub.  Util.  Commissioners,  87  Atl.  651 
Re  Manitowoc  Water  Works  Co.,  7  W.R.C.R.  71;  Re  Queens  Borough 
Gas  &  Elec.  Co.,  2  P.S.C.  (1st.  Dist.)  N.Y.;  Mayhew  v.  Kings  County 
Lighting  Co.,  2  P.S.C.  (1st.  Dist.)  N.Y.;  Spring  Valley  Water  Works  v. 
San  Franscisco,  192  Fed.  137;  see  also  Willcox  v.  Consol.  Gas  Co.,  212  U.S. 
19,  29  Sup.  Ct.  192,  53  L.  ed.  382;  Omaha  Water  Works  Co.  v.  Omaha,  218 
U.S.  180,  202,  54  L.  ed.  991,  30  Sup.  Ct.  615;  Rept.  of  Nat'l  Ass'n  of  Ry. 
Commissioners,  23d  Convention,  Oct.  1911,  p.  145;  Rept.  of  Mass.  Joint 
Comm.  on  N.Y.,  N.H.  &  Hartford  R.R.  Co.  1911,  pp.  51-154. 

«  165  Fed.  667. 


64  FAIR  VALUE 

The  idea  that  a  valuable  franchise  could  be  taken  in  condemna- 
tion proceedings,  without  compensation,  would  not  be  tolerated 
for  an  instant  and  to  permit  such  a  franchise  to  be  taken  without 
consideration  indirectly,  by  means  of  rate  regulation,  is  equally 
obnoxious  to  the  Federal  Constitution. 

The  analogy  was  absurd,  and  the  Supreme  Court  at  ap- 
proximately the  same  date  refused  to  include  any  franchise 
value  other  than  such  as  had  been  established  by  statute.1 
It  is  by  the  recognition  of  elements  of  value  in  rate  cases 
which  have  no  place  in  condemnation  proceedings,  and  the 
refusal  to  recognize  elements  which  are  essential  to  a  valua- 
tion for  eminent-domain  cases,  that  the  fact  is  most  clearly 
brought  out  that  no  ground  for  analogy  between  the  two 
exists. 

The  analogy  with  condemnation  cases  has  arisen  in  two 
ways,  by  comparison  of  rate-making  proceedings  and  con- 
demnation cases,  and  by  comparison  of  valuation  for  con- 
demnation and  for  rate-making.  The  theory  which  supports 
the  analogy  between  the  two  types  of  proceedings  is  in- 
herently unsound.  Condemnation  under  the  power  of  emi- 
nent domain  is  the  taking  of  private  property  for  public  use 
on  payment  of  due  compensation.  The  payment  of  just 
compensation  whenever  private  property  is  taken  is  com- 
pulsory under  "  the  law  of  the  land  "  and  the  Federal  Con- 
stitution. If  the  analogy  holds  true  and  a  rate  reduction 
takes  private  property,  there  must  be  compensation  pro- 
portionate to  the  reduction.  The  vicious  circle  is  encoun- 
tered again. 

A  more  logical  explanation  of  the  tangle  is  that  the  pub- 
lic takes  the  use  of  utility  property  because  of  the  common- 
law  requirement  that  all  applicants  must  be  served;  and 
that  rate-making  fixes  the  compensation  for  the  taking. 
Rates  paying  fairly  for  the  use  are  legal;  those  returning 
less  are  unconstitutional.  The  argument  is  false  from  the 

1  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  29  Sup.  Ct.  192, 53  L. 
ed.  382. 


VALUATION  AND  REGULATION  65 

economic  viewpoint  because  the  owner  gets  profit,  not  rent, 
and  it  does  not  fit  the  legal  situation.  Jurists  insist  that  reg- 
ulation and  rate-making  are  an  exercise  of  the  police  power, 
not  of  the  power  of  eminent  domain.  And  the  police  power 
takes  property  without  compensation. 

It  might  be  argued  that  the  due-process  clause  applies  to 
the  taking  of  profits  rather  than  use,  and  that  earnings 
above  a  certain  point  are  not  private  property  and  for  that 
reason  can  be  taken  with  immunity  by  the  public,  but  be- 
low that  point  earnings  are  private  property  and  cannot 
be  taken  without  compensation.  Such  reasoning  would 
comply  with  the  social  theory  which  holds  all  return  above 
a  reasonable  profit  to  be  the  property  of  the  public.  But  so 
long  as  the  taking  refers  to  earnings,  the  vicious  circle  re- 
mains, for  earnings  are  dependent  upon  rates. 

There  is  only  one  solution  of  the  situation  created  by 
judicial  interpretation.  It  is  that  what  is  taken  is  neither  the 
property,  the  use  of  the  property,  nor  the  profits.  The  serv- 
ice and  nothing  but  the  service  is  taken.1  So  long  as  the 
consumer  pays  the  just  rate  for  the  service  there  is  pur- 
chase of  service,  but  no  taking  by  the  State.  The  moment 
the  State  prohibits  the  utility  from  collecting  that  rate, 
there  is  a  taking  of  service.  The  rate  was  fixed  by  the  com- 
mon law  and  the  Constitution  has  not  changed  the  limita- 
tion. The  criterion  is  the  reasonable  worth  of  the  service 
taken. 

When  the  legislature  fixes  a  rate  below  the  point  of  rea- 
sonable return,  it  is  exercising  its  power  of  eminent  domain, 
by  taking  service  in  addition  to  that  which  the  consumer 
pays  for,  and  the  courts  may  intervene  on  the  basis  of  fail- 
ure to  use  due  process  of  law  by  reason  of  the  neglect  to  sup- 
ply adequate  compensation  for  the  service  taken.  When  the 

1  The  property  may  inadvisably  be  employed  in  producing  a  public  serv- 
ice under  conditions  which  preclude  a  profit  if  the  service  is  sold  at  its 
reasonable  value.  In  such  cases  rates  which  paid  the  full  worth  of  the  serv- 
ice to  the  consumer  would  be  constitutional,  though  no  profit  were  pro- 
vided. 


66  FAIR  VALUE 

legislature  fixes  a  rate  above  that  point,  it  is  exercising  its 
rate-making  power  and  the  courts  cannot  interfere.  The  leg- 
islature has  at  no  time  had  any  thought  of  condemning  the 
property,  and  no  court  has  determined  just  compensation. 
But  these  elements  of  the  situation  prove  the  failure  to  em- 
ploy due  process,  rather  than  that  the  power  of  eminent 
domain  has  not  been  exercised  when  the  rate  is  unreasona- 
bly low. 

Two  separate  and  distinct  governmental  powers  are  un- 
der consideration,  the  police  power  and  eminent  domain. 
The  differences  between  them  are  many.  In  condemnation 
cases  the  title  to  the  property  is  taken,  all  use  of  the  prop- 
erty by  the  former  owner  is  prevented,  all  elements  of 
value,  in  so  far  as  he  is  concerned,  are  destroyed.  In  rate 
cases  not  the  title  to  the  property,  nor  even  the  privilege 
to  use  it  in  any  certain  manner  is  taken,  but  the  privilege 
of  asking  more  than  a  certain  return  for  the  use  of  the  prop- 
erty in  a  certain  manner  is  denied.  No  attempt  is  made  to 
compel  such  use.  No  force  is  employed  to  prevent  other 
uses.  At  most  but  a  minor  element  of  value  is  destroyed  in 
rate  cases  as  opposed  to  all  value  in  condemnation  cases. 
Rate-making,  therefore,  involves  no  payment  of  compensa- 
tion for  the  value  destroyed.  It  is  destruction  for  the  com- 
mon good.  It  is  not  taking  at  all.  The  State  receives  nothing. 
Nothing  is  to  be  paid  for.  The  utility  is  merely  prevented 
from  appropriating  the  public  interest  in  profits  for  private 
benefit,  restrained  from  violating  the  common-law  obliga- 
tion of  serving  at  a  reasonable  rate.  Condemnation  takes 
value.  The  State  receives  value  and  must  make  payment 
for  it. 

When  a  certain  point  has  been  reached  the  Court  says : 
thus  far  rate-making  may  go  and  no  farther.  If  rates  are 
reduced  lower,  the  utility  will  not  be  paid  the  worth  of  the 
service.  The  State  is  no  longer  restraining  private  appro- 
priation of  public  interest;  it  is  appropriating  private  in- 
terest. The  difference  between  the  rate  the  consumer  says 


VALUATION  AND  REGULATION  67 

and  the  reasonable  rate  is  taken  by  the  State  for  the  public 
welfare.  If  such  taking  is  deemed  necessary  in  the  interest 
of  society,  it  must  be  accomplished  through  the  power  of 
eminent  domain  and  compensation  must  be  made  for  the 
loss.  Rate-making  is  confined  to  the  determination  of  the 
fair  return. 

The  law  is  interpreted  to-day  as  it  has  just  been  stated. 
It  is  illogical  and  confusing.  It  strains  legal  theory  to  the 
breaking  point.  It  is  wholly  out  of  accord  with  the  funda- 
mental concepts  of  the  Nation's  legal  system.  But  it  is 
binding.  It  is  the  suspended  axe  under  which  legislatures 
and  commissions  must  exercise  their  rate-making  powers. 
Such  an  interpretation  of  the  law  is  based  upon  the  fun- 
damental distinction  between  public  utilities  and  other 
industry,  yet  it  absolutely  ignores  that  distinction.  This  in- 
consistency has  bred  the  great  majority  of  misunderstand- 
ings that  have  blocked  the  successful  application  of  the 
valuation  theory. 

There  is  no  possible  application  of  the  condemnation 
analogy  to  property  valuation  for  rate-making  which  is  not 
inconsistent  with  the  fundamental  principles  of  govern- 
ment control  and  with  the  theory  of  private  property  it- 
self. The  value  of  the  service  which  would  be  taken  without 
compensation  if  the  unreasonable  rates  were  enforced,  is  the 
only  value  which  is  to  be  determined  by  condemnation 
methods  under  the  legal  theory  of  rate-making.  The  value 
of  the  physical  property  of  the  utility  is  not  fixed  for  rate- 
making  upon  that  basis,  for  such  property  is  not  taken. 

The  conception  of  rate-making  as  a  condemnation  proc- 
ess is  a  regrettable  attempt  to  reinstate  laissez-faire,  indi- 
vidualistic ideas  and  apply  them  to  a  legal  and  economic 
situation  wholly  out  of  accord  with  those  principles.  The 
result  is  that  the  courts  and  commissions  have  been  forced 
to  disregard  the  makeshift  doctrine  at  fully  as  many  points 
as  they  have  been  able  to  apply  it.  Inconsistencies,  confu- 
sion, and  unsuccessful  regulation  have  been  inevitable,  and 


68  FAIR  VALUE 

will  remain  so  until  the  Supreme  Court  of  the  United  States 
summons  up  courage  directly  to  reverse  itself  and  disregard 
the  hybrid  to  which  it  has  given  birth. 

A  reversal  of  position  as  to  the  due-process  clause  in  its 
application  to  legislative  action  under  the  police  power 
would  not  necessarily  carry  with  it  a  rejection  of  the  valua- 
tion doctrine.  It  would  not  lessen  the  protection  afforded 
private  property,  nor  lower  the  return  allowed  for  utility 
service.  The  public  utility  has  undertaken  the  conduct  of  a 
governmental  function  for  the  benefit  of  the  public,  be- 
cause the  Government  has  deemed  it  expedient  to  have 
that  function  performed  by  private  individuals  under 
government  control.  A  general  public  offer  has  been  made 
to  induce  capitalists  to  undertake  this  service.  An  implied 
condition  of  that  offer,  absolutely  essential  to  its  success,  is 
that  fair  remuneration  will  be  allowed  for  the  service  ren- 
dered. It  would  be  irrational  to  assume  that  the  offer  of  the 
State  would  be  accepted  by  an  individual  unless  it  did  con- 
tain such  provision.  The  privilege  of  collecting  rates  is  given 
to  the  utility  as  consideration  for  undertaking  the  service. 
These  rates  are  in  reality  taxes  levied  directly  on  those  who 
derive  the  benefit  in  much  the  same  way  as  a  special  assess- 
ment is  apportioned.  The  acceptance  of  the  offer  constitutes 
a  binding  contract  between  the  State  and  the  individual 
undertaking  the  service.  In  undertaking  the  public  service 
the  utility  submits  itself  to  the  obligations  imposed  by  the 
common  law.  It  assumes  a  heavy  burden  which  carries  with 
it  the  implied  right  to  collect  a  reasonable  return  for  ren- 
dering the  service.  The  government,  by  compelling  the  com- 
pany to  serve  all  applicants  and  by  accepting  the  service, 
obligates  itself  to  make  reasonable  payment  for  it.  The  con- 
tract between  the  State  and  the  utility,  in  the  absence  of  a 
specific  provision  to  the  contrary,  raises  an  implied  agree- 
ment as  to  rates.  The  obligation  of  the  contract  cannot  be 
impaired  by  the  State  without  violation  of  the  Federal 
Constitution.  The  consideration  contemplated  by  the  terms 


VALUATION  AND  REGULATION  69 

of  the  implied  agreement  is  paid,  so  long  as  the  payment 
vmade  to  the  utility  by  way  of  rates  collected  for  the  ser- 
ice  rendered  adequately  compensates  the  utility  operator; 
and  if  the  State  does  not  prevent  this  by  regulation  it  has 
performed  its  part  of  the  contract.  The  moment  the  State 
reduces  charges  for  service  below  the  point  of  adequate 
compensation,  the  rates  become  unreasonable,  the  contract 
obligation  is  impaired,  and  the  State  has  violated  the  pro- 
visions of  the  Federal  Constitution.  The  law  fixing  such  a 
rate  is,  therefore,  unconstitutional.  The  result  of  such  an 
interpretation  of  the  law  gives  to  private  property  the  same 
protection  that  it  enjoys  under  the  condemnation  theory, 
so  far  as  that  theory  can  be  put  into  practice  at  all.  It  is  in 
accord  with  the  legal  theories  of  American  jurisprudence 
and  with  the  fundamental  principles  of  private  property 
and  government  regulation.  It  does  not  strain  legal  theory 
as  the  application  of  the  condemnation  analogy  to  the  oper- 
ation of  the  police  power  does.  It  unfortunately,  however, 
is  not  the  interpretation  adopted  by  the  courts  or  that  to 
which  valuation  must  conform.  Its  acceptance  would  clear 
the  confusion  produced  by  the  application  of  the  individual- 
istic theories  to  a  quasi-public  undertaking.  But  it  has  not 
been  accepted.  A  statement  of  it  may  assist  the  reader  in 
unraveling  some  of  the  tangled  threads  of  the  valuation 
process,  but  it  can  be  of  no  further  service. 

The  argument  that  a  valuation  for  rate-making  pur- 
poses should  be  computed  upon  the  same  basis  as  a  valua- 
tion for  condemnation  proceedings  is  as  erroneous  as  the 
application  of  the  analogy  to  the  exercise  of  the  police 
power.  To  view  the  question  properly  it  is  necessary,  at 
this  point,  to  analyze  the  actual  proceedings  in  rate  cases. 
A  public-utility  rate  proceeding  arises  thus: 
The  legislature  either  directly,  or  by  delegation  of  its 
power  to  a  commission  created  by  it,  fixes  the  rate  which  it 
will  permit  the  utility  to  charge.  In  doing  this  it  exercises 
an  undisputed  legislative  function.  One  of  the  public  utili- 


70  FAIR  VALUE 

ties  subject  to  the  schedule  or  rate  thus  fixed  conceives  the 
idea  that  the  rate  is  unreasonable.  Its  constitutionality  is 
attacked  in  the  courts.  Their  sole  duty  is  to  decide  the  con- 
stitutional issue  —  the  constitutionality,  not  the  reason- 
ableness, of  the  rate  is  in  question. 

The  complaint  states  that  part  of  the  bundle  of  rights 
which  constitute  the  private  property  employed  in  the  util- 
ity business  has  been  taken  by  the  public;  that  this  taking 
is  such  as  can  be  accomplished  only  under  the  power  of 
eminent  domain  after  just  compensation;  that  the  taking 
has  been  attempted  through  the  exercise,  not  of  the  power 
of  eminent  domain,  but  of  the  police  power,  and  is  there- 
fore without  due  process  of  law,  and  that  as  such  taking  is 
confined  to  public  utilities  they  are  denied  the  equal  pro- 
tection of  the  laws,  all  in  violation  of  the  first  section  of  the 
Fourteenth  Amendment  to  the  Federal  Constitution. 

The  right  to  make  a  return  on  the  property  is  the  only 
right  in  the  whole  bundle  affected,  and  it  is  affected  only 
to  the  extent  of  the  difference  between  the  rate  fixed  and 
the  reasonable  rate.  That  part  of  that  property  right  is  in- 
directly taken.  The  rights  of  possession,  of  disposal,  and  of 
use  are  untouched.  The  condemnation  theory  of  valuation 
proceeds  directly  contrary  to  fact  and  considers  all  rights  as 
denied,  for  such  is  the  case  where  the  property  is  taken  by 
eminent-domain  proceedings.  When  a  water  plant  is  con- 
demned, the  entire  premises,  the  complete  equipment,  is 
taken.  Abandoned  machinery  still  on  the  premises  and 
equipment  far  in  excess  of  present  needs,  though  neither 
used  nor  useful  for  utility  purposes,  must  be  paid  for  as 
part  of  the  plant.  In  a  rate  valuation  such  property  is  not 
included.  Service  is  taken  and  the  worth  of  the  service  must 
be  paid  by  way  of  compensation.  Such  property  adds  noth- 
ing to  the  value  of  the  service,  so  cannot  be  considered.  The 
right  to  a  return  is  affected.  And  the  owner  has  a  right  to  a 
return  only  on  that  part  of  the  property  that  is  actually 
used  and  useful  in  rendering  the  public  service. 


VALUATION  AND  REGULATION  71 

Similarly  lands  and  privileges  granted  to  the  utility  by 
the  public  have  no  place  in  a  valuation  for  rate  purposes, 
for  the  property  was  donated  to  facilitate  the  public  use, 
not  private  gain,  and  the  gift  carried  with  it  no  right  to  a 
return  upon  the  property.  The  donee  holds  but  the  naked 
title  of  a  trustee,  the  return  reverts  to  the  public  as  cestui 
que  trust.  Denial  of  a  return  on  such  property  is  restrictive 
action  under  the  police  power  in  protection  of  the  public's 
interest,  not  a  taking  of  private  interest. 

Advocates  of  the  condemnation  theory  have  been  found, 
however,  who  will  sacrifice  the  part  to  save  the  remainder, 
and  claim  that  that  which  is  taken  can  be  valued  by  the 
same  process  which  is  applied  in  condemnation  cases.  When 
this  stage  is  reached  the  value  to  the  utility  of  the  condem- 
nation theory  is  practically  destroyed,  for  its  main  objec- 
tive is  the  saving  to  the  utility  of  a  rate  of  return  on  property 
not  properly  included  in  a  rate  valuation.  Even  at  this 
point,  however,  the  theory  will  not  stand  analysis. 

Rate-making  values  property  not  to  determine  a  price  to 
be  paid  for  the  property  itself,  but  to  fix  the  reasonable  cost 
of  the  service  it  helps  to  render.  Condemnation  proceedings 
value  property  to  estimate  the  reasonable  price  to  be  paid 
for  the  property  itself.  The  two  cases  cannot  with  fairness 
be  decided  by  the  same  standards.  If  a  condemnation  valua- 
tion were  adopted  for  both,  the  public  interest  would  be 
sacrificed  in  rate  cases.  If  a  rate  valuation  were  adopted,  the 
utility's  private  rights  would  be  violated  in  condemnation 
cases.  The  reason  back  of  the  desire  to  carry  the  con- 
demnation theory  to  rate  cases  is  now  apparent.  There 
remains  to  be  considered  the  extent  to  which  the  courts 
have  been  misled  by  insistent  appeal  to  this  analogy  on 
the  part  of  counsel  for  the  utilities. 

IX.  San  Diego  Land  and  Town  Company  v.  National  City 

Reverting  then  to  the  consideration  of  the  development 

of  the  theory  of  valuation,  we  find  that  the  questions  pre- 


72  FAIR  VALUE 

sented  in  the  case  of  Smyth  v.  Ames,  last  discussed,  were 
brought  before  the  Court  again  the  following  year  in  the 
case  of  the  San  Diego  Land  and  Town  Company  v.  National 
City.1  After  reviewing  Smyth  v.  Ames  and  Covington  Road 
Company  v.  Sandford,  the  Court  adds  to  the  test  of  rate 
regulation  set  up  in  the  former  case  the  element  of  reason- 
ableness to  the  public,  protected  fully  in  the  earlier  case, 
but  not  definitely  included  in  its  enumerated  items  of  the 
elements  of  value.  The  Court  said: 

The  contention  of  the  appellant  in  the  present  case  is  that  in 
ascertaining  what  are  just  rates  the  Court  should  take  into  consid- 
eration the  cost  of  its  plant;  the  cost  per  annum  of  operating  the 
plant,  including  interest  paid  on  money  borrowed,  and  reasonably 
necessary  to  be  used  in  constructing  the  same;  the  annual  depre- 
ciation of  the  plant  from  natural  causes  resulting  from  its  use; 
and  a  fair  profit  to  the  company  over  and  above  such  charges  for 
its  service  in  supplying  the  water  to  consumers,  either  by  way  of 
interest  on  the  money  it  has  expended  for  the  public  use,  or  upon 
some  other  fair  and  equitable  basis.  Undoubtedly  all  these  mat- 
ters ought  to  be  taken  into  consideration,  and  such  weight  be  given 
them  tohen  rates  are  being  fixed  as  under  all  the  circumstances  will  be 
just  to  the  company  and  to  the  public.  The  basis  of  calculation  sug- 
gested by  the  appellant  is,  however,  defective  in  not  requiring  the 
real  value  of  the  property  and  the  fair  value  in  themselves  of  the 
services  rendered  to  be  taken  into  consideration.  What  the  com- 
pany is  entitled  to  demand,  in  order  that  it  may  have  just  compen- 
sation, is  a  fair  return  upon  the  reasonable  value  of  the  property 
at  the  time  it  is  being  used  for  the  public.  The  property  may  have 
cost  more  than  it  ought  to  have  cost  and  its  outstanding  bonds 
for  money  borrowed  and  which  went  into  the  plant  may  be  in 
excess  of  the  real  value  of  the  property. 

The  new  element  to  be  considered  is  "the  fair  value  in 
themselves  of  the  services."  The  value  of  the  property  can- 
not determine  the  rate  regardless  of  the  value  of  the  service 
rendered.  It  is  the  theoretical  or  reasonable  cost  of  serv- 
ice which  the  court  seeks  to  determine,  not  the  actual  cost. 

The  case  brings  out,  too,  the  point  that  the  enumeration 
of  elements  of  value  in  the  Ames  Case  is  not  the  establish- 
1  174  U.S.  739,  19  Sup.  Ct.  804,  43  L.  ed.  1154. 


VALUATION  AND  REGULATION  73 

ment  of  a  rule  of  valuation.  The  elements  set  forth  must  be 
considered  in  relation  to  the  circumstances  of  the  case. 
Outstanding  bonds  may  be  disregarded  where  they  repre- 
sent no  real  value.  Original  cost  must  be  restricted  to  rea- 
sonable cost,  etc.  The  elements  stated  in  the  Ames  Case 
may  or  may  not  be  entitled  to  consideration  depending 
upon  the  particular  circumstances  in  question. 

X.  Valuation  as  a  Test  for  Individual  Rates 

Thus  far  the  valuation  theory  has  been  applied  to  deter- 
mine the  reasonableness  of  entire  rate  schedules  only.  Its 
applicability  in  cases  involving  a  single  rate  is  still  to  be 
affirmed.  That  problem  came  before  the  Court  in  the  case 
of  the  Minneapolis  and  St.  Louis  Railroad  Company  v. 
Minnesota,1  wherein  the  Court  held  a  rate  on  coal  in  car- 
load lots  reasonable  and  non-confiscatory,  though  if  all 
freight  were  subjected  to  a  similar  rate  the  road  would  not 
be  able  to  earn  operating  expenses. 

In  the  case  of  the  Northern  Pacific  Railway  Company  v. 
North  Dakota2  the  question  arose  again  and  the  Court  held 
that  the  rate  on  coal  could  not  be  placed  at  so  low  a  figure 
that  the  carriage  of  the  coal  would  not  produce  a  reasonable 
return  in  addition  to  operating  expenses,  etc.,  even  though 
the  total  return  to  the  railroad  from  all  traffic  carried  would 
be  adequate.  The  Minnesota  Case  was  distinguished  on  the 
ground  that  the  rate  on  coal  there  established  was  not 
shown  to  be  an  unreasonable  rate  for  the  coal  traffic  itself. 

The  valuation  doctrine  of  the  Ames  Case  is  therefore  to 
be  applied  both  to  the  return  from  any  given  rate  and  to  the 
return  from  the  entire  rate  schedule. 

XL  The  Recent  Decisions 

The  recent  decisions,  with  one  exception,  add  nothing  to 
the  fundamental  valuation  principles  thus  far  developed. 
They  determine  the  propriety  of  including  or  excluding 
1  186  U.S.  257.  2  236  U.S.  585,  59  L.  ed.  735. 


74  FAIR  VALUE 

specific  elements  of  value,  or  of  arriving  at  fair  value  by 
this  or  that  method. 

The  exception  is  the  decision  in  Knott  v.  The  Chicago, 
Burlington  and  Quincy  Railroad  Company,  commonly 
known  as  the  Missouri  Rate  Case.1  In  this  proceeding  the 
Supreme  Court  condemned  valuation  for  rate  purposes  ar- 
rived at  by  multiplying  the  tax  assessment  figures  by  three. 
Aside  from  the  statement  that  valuation  for  rate  control 
must  be  made  with  this  purpose  in  view,  which  may  be 
radically  different  from  that  in  other  valuation  proceedings, 
the  case  adds  nothing  to  those  already  discussed. 

XII.  Summary 

The  growth  of  the  valuation  theory  has  been  gradual. 
For  a  number  of  years  after  it  was  first  suggested  the  courts 
hesitated  to  interfere  in  rate-making  lest  they  should  as- 
sume legislative  functions.  But  the  laws  they  were  placed  in 
office  to  enforce,  the  Constitution,  and  the  procedure,  all 
having  been  developed  during  the  ascendency  of  the  indi- 
vidualistic laissez-faire  epoch,  sanctified  private  property 
to  such  an  extent  that  the  Court  found  itself  constrained  to 
intervene.  Rate  control  through  commissions  was  subjected 
to  the  limitation  of  reasonableness.  The  check  was  vague. 
The  Court  was  feeling  its  way.  Without  defining  the  limit 
the  Court  extended  it  to  direct  legislative  rate-making. 
Pressed  by  extreme  adverse  criticism  and  wholesale,  un- 
veiled charges  of  having  resorted  to  judicial  legislation  in 
the  interest  of  wealth,  the  Court  sought  a  basis  for  its  in- 
terference. The  condemnation  analogy,  which  likened  val- 
uation for  determining  the  cost  of  service  to  valuation  for 
fixing  a  price  on  the  property  valued,  was  tested  and  dis- 
carded. The  analysis  of  the  due-process  clause  which  was 
forced  into  prominence  just  at  this  time,  by  its  reference 
to  the  "law  of  the  land,"  supplied  the  argument. 

The  police  power  is  restrictive  in  its  action.  It  may  de- 
1  230  U.S.  474,  33  Sup.  Ct.  975. 


VALUATION  AND  REGULATION  75 

stroy  property  to  protect  the  public,  but  it  cannot  take  it 
for  the  public,  without  compensation.  The  law  of  the  land 
requires  compensation  when  property  is  taken.  The  police 
power,  therefore,  cannot  be  extended  to  the  actual  taking 
of  property.  The  courts  were  unwilling  to  consider  rate- 
making  except  as  an  exercise  of  the  police  power.  They 
declined  to  classify  it  as  condemnation  of  the  service.  A 
sort  of  hybrid  theory  of  regulation  resulted,  which  holds 
that  the  State,  in  the  exercise  of  its  police  power,  may  limit 
the  return  to  prevent  the  utility  from  appropriating  the 
interest  of  the  public,  but  cannot  take  the  service  without 
paying  the  utility  what  it  is  really  worth.  When  such  a 
point  in  rate-making  is  reached  the  power  of  eminent  do- 
main, not  the  police  power,  is  enforced,  and  the  due  process 
required  by  the  Fourteenth  Amendment  is  lacking  if  com- 
pensation is  neglected.  The  equal  protection  of  the  law  is 
denied  the  utilities  because  other  business  is  not  subjected 
to  such  confiscation.  The  right  of  the  judiciary  to  intervene 
and  enforce  the  constitutional  safeguards  of  property  was 
established. 

The  tests  to  be  applied  in  that  intervention  were  not  de- 
cided upon  at  first.  Valuation  had  been  suggested  and  re- 
jected before  the  power  to  review  rate-making  was  estab- 
lished. The  only  form  of  valuation  known  was  that  applied 
in  condemnation  cases.  It  did  not  fit  the  situation  because 
the  value  of  the  utility's  property  was  sought  to  determine 
the  cost  of  the  service,  not  to  fix  the  price  of  the  property. 
The  Court  hesitated  to  adopt  valuation,  but  finally  took  the 
step.  Having  done  so,  it  realized  the  opportunity  for  injury 
to  the  public  welfare  which  rate-making  sought  to  protect 
and  hastened  to  place  conditions  upon  valuation.  Capital- 
ization, the  value  of  outstanding  securities,  the  actual  value 
of  the  property,  because  they  might  be  excessive  and  rep- 
resent poor  management  or  even  fraud,  could  not  be  ac- 
cepted as  the  criterion  of  value.  Wear  and  tear  on  the  equip- 
ment required  a  reduction  of  value  by  way  of  depreciation. 


76  FAIR  VALUE 

In  glaring  generalities  the  situation  was  summed  up  by  say- 
ing that  the  utility  was  entitled  to  a  "fair  return"  upon  the 
"present  fair  value"  of  the  "property  used  and  useful"  in 
rendering  the  public  service,  and  the  public  was  entitled  to 
service  at  a  figure  not  above  its  actual  worth.  None  of  the 
decisive  terms  were  defined  by  the  Court. 


CHAPTER  IV 
THE  THEORY  OF  VALUATION 

I.  Valuation  and  Economics 

The  place  of  valuation  in  public-utility  regulation  is  a 
legal  question,  but  the  principles  applied  are  economic. 
Valuation,  like  any  other  legal  action,  may  disregard  eco- 
nomic principles,  but  is  bound  to  prove  unjust  and  unsatis- 
factory if  it  does  so.  The  business  world  is  controlled  by 
economic  laws.  Legislative  or  judicial  action  taken  without 
regard  for  those  laws  inevitably  produces  friction,  economic 
waste,  and  political  dissatisfaction. 

It  is  not  difficult  to  learn  the  rules  which  form  the  law  of 
valuation,  but  that  law  is  in  an  admittedly  chaotic  state, 
and  it  avails  little  to  segregate  the  authentic  statements  of 
the  courts  from  discarded  principles  and  dicta.  The  deci- 
sions have  been  stated  chronologically  to  show  how  one  was 
built  upon  another  to  arrive  at  the  final  conglomerate  struc- 
ture. An  attempt  has  been  made  to  consider  them  and  say 
herein  did  the  Court  err  or  at  this  point  legal  requirement 
departs  from  economic  principles.  But  this  is  solely  adverse 
and  destructive  criticism.  Constructive  thought  is  needed. 
Little  aid  can  be  derived  from  the  knowledge  that  the  law 
is  in  conflict  with  economic  rules  if  we  do  not  learn  the  na- 
ture of  the  conflict  and  determine  how  it  can  be  avoided.  It 
is  for  this  reason  that  we  have  braved  the  charge  of  irrele- 
vancy and  gone  below  the  surface  of  valuation  law  to  con- 
sider the  status  of  property  and  the  general  aims  of  regula- 
tion before  discussing  the  development  of  the  valuation 
principle  or  attempting  to  analyze  it. 

II.  The  Meaning  of  Value 

The  first  problem  in  considering  valuation  is  the  defini- 
tion of  "value."  It  must  be  admitted  at  the  start  that  the 


78  FAIR  VALUE 

term  is  used  with  widely  varying  meaning.  Economists 
have  always  recognized  the  vernacular  use  of  the  term  and 
the  numerous  resulting  ideas  of  value,  though  Economics 
itself  has  been  almost  exclusively  concerned  with  "ex- 
change value."  Even  the  ancient  thinkers  recognized  the 
twofold  division  of  value  with  which  Adam  Smith  con- 
fused economic  thought  for  decades. 

Value  may  be  either  subjective  or  objective.  We  may 
speak  of  heat  or  light  value  as  well  as  exchange  value. 
The  term  may  be  synonymous  with  utility.  It  may  mean 
abstract  purchasing  power,  purchasing  power  measured 
in  commodities  or  in  money,  the  average  price,  or  the 
"proper  and  legitimate  price." 

Professor  Hadley  has  drawn  a  twofold  division,  even 
within  the  field  of  economic  value,  which  is  of  particular 
interest  here.  He  classifies  value  according  to  a  com- 
mercial and  social  theory  closely  allied  to  the  dual  nature 
of  property  already  considered.  He  says: 

Value  being  essentially  an  ethical  term,  we  may  have  as  many 
different  theories  of  value  as  there  are  different  views  of  business 
ethics.  But  these  views  fall  under  two  main  heads :  The  commer- 
cial or  competitive  theory  which  bases  value  upon  what  the  buyer 
is  willing  and  able  to  offer  for  an  article;  and  the  socialistic  theory 
which  bases  it  upon  what  the  article  has  cost  the  seller  in  the  way 
of  toil  and  sacrifice.1 

The  loose  usage  of  the  term  "value,"  antedating  by  cen- 
turies the  valuation  doctrine,  and  the  disagreement  of  econ- 
omists even  as  to  the  fundamentals  of  economic  value  it- 
self, should  suggest  the  scholastic  folly  of  the  superficial 
squabble  over  the  propriety  of  using  the  term  "valuation" 
in  utility  regulation,  which  has  marred  much  of  valuation 
literature.  The  term  "fair  value,"  however  regrettable,  has 
been  irrevocably  incorporated  in  our  vocabulary  and  must 
be  accepted.  This  being  true,  time  can  be  spent  with  more 

1  Hadley,  Economics,  sec.  105. 


[THE  THEORY  OF  VALUATION]  79 

profit  in  determining  the  meaning  of  the  term  than  in  ques- 
tioning the  judgment  displayed  in  adopting  it. 

III.  The  Varying  Uses  of  Valuation 

The  greater  part  of  valuation  literature  has  dealt  with 
the  determination  of  fair  value  for  rate-making  purposes. 
This,  however,  is  but  one  of  the  many  phases  of  the  ques- 
tion. Valuation  is  a  part  of  the  general  regulatory  pro- 
gramme. It  underlies  almost  every  feature  of  regulation. 
In  addition  to  its  place  in  rate-making,  it  serves  as  a  basis 
for  control  of  capitalization  to  prevent  stock-watering.  It 
fixes  the  foundation  of  security  issues  and  enables  the  Gov- 
ernment to  protect  the  stockholder,  the  bondholder,  and 
the  consumer  from  illegitimate  financial  practices.  It  forms 
the  basis  upon  which  questions  of  purchase  and  sale  are  de- 
cided, reorganizations  and  consolidations  permitted,  taxa- 
tion levied,  and  private  plants  taken  over  by  the  Govern- 
ment. 

It  requires  little  consideration  of  regulatory  problems  to 
arrive  at  the  conclusion  that  valuation  for  capitalization, 
for  purchase  and  sale,  for  rate-making,  and  for  taxation 
purposes  cannot  all  be  made  upon  the  same  basis.  There 
are  as  many  forms  of  valuation  as  there  are  distinct  phases 
of  regulation  based  upon  property  value.1 

1  Proceedings  of  National  Ass'n  of  Ry.  Commissioners,  1911,  p.  145, 
1913,  p.  279;  see  also  Report  of  Mass.  Joint  Comm.  on  N.Y.,  N.H.  & 
Hartford  R.R.  Co.,  Feb.  15,  1911,  p.  55;  In  re  Express  Rates,  Ind. 
R.R.  Comm.  No.  495;  "The  fact  that  the  State  has  taxed  the  company 
upon  its  franchises  at  a  greater  value  than  is  awarded  them  here  is  not  ma- 
terial," Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  51,  29  Sup.  Ct.  192; 
53  L.  ed.  382;  Hill  v.  Antigo  Water  Co.,  3  W.R.C.R.  623,  728;  In  re  Mani- 
towoc Water  Works  Co.,  7  W.R.C.R.  71,  72;  "Value  is  an  elusive  term, 
and  what  may  properly  be  a  value  for  one  purpose  may  be  entirely  im- 
proper as  a  value  for  another  purpose."  In  re  Stockton  Terminal  (Cal.), 
19  Am.  T.  &  T.  Co.  Comm.  Leaflets,  p.  208;  Furhmann  v.  Cataract  Power 
&  Conduit  Co.,  3  P.S.C.  (N.Y.)  2d  Dist.  656,  691;  Public  Service  Gas  Co. 
v.  Bd.  of  Public  Utility  Comm.  (N.J.)  87  Atl.  651,  658;  etc.  Contra.  State 
ex  rel.  Bee  Bldg.  Co.  v.  Savage,  65  Neb.  714,  dictum;  St.  Louis  &  S.F.R. 
Co.  v.  Hadley,  168  Fed.  317;  etc. 


80  FAIR  VALUE 

In  valuing  a  public  utility  for  tax  purposes  it  is  immate- 
rial to  what  use  the  property  is  put,  or  what  return  it  pro- 
duces. In  valuing  the  same  utility  for  rate-making  the  use 
of  the  property  becomes  important  and  in  fixing  the  sale 
value  the  return  may  be  considered.  The  purpose  of  valua- 
tion is  different  in  each  case.  In  levying  a  tax  the  private 
property  of  the  utility  stands  in  no  different  position  from 
other  private  wealth.  The  public  interest  in  the  use  of  the 
property  is  not  involved.  In  purchase-and-sale  cases  that 
interest  is  in  question  only  indirectly  because  the  valua- 
tion fixed  may  have  a  bearing  upon  future  rate  cases  and 
financial  regulation.  In  rate  cases  the  public  interest  is 
predominant. 

IV.  Fair  Value  not  Exchange  Value 

It  is  clear,  since  no  one  standard  of  value  is  applicable  in 
all  cases,  that  "fair  value"  is  not  exchange  value.1  Valua- 
tion for  rate-making  cannot  be  exchange  value,  for  that  it- 
self depends  upon  rates  and  income,  and  rates  and  income 
are  the  very  things  which  valuation  alters.  The  fair  value 
for  rate-making  must  be  determined  before  exchange  value 
can  be  found;  therefore  the  two  cannot  possibly  be  identical. 
The  two  values  are  antagonistic.  It  has  been  pointed  out 
that  the  purpose  of  regulation  is  to  destroy  value.  Private 
interest  is  wiped  out  as  inconsistent  with  the  public  inter- 
est. In  determining  commercial  or  exchange  value  the  proc- 
ess would  be  to  ascertain  the  net  earnings  under  present 
rates,  by  deducting  operating  expenses,  depreciation,  and 
taxes  from  gross  revenue,  and  capitalize  these,  taking  into 
consideration  appreciation  of  land  and  the  value  of  property 
not  used  in  the  public  service.  It  is  to  avoid  exactly  this 
valuation,  rates  based  thereon,  and  the  speculative  element 

1  See  In  re  Westchester  St.  Ry.  Co.,  wherein  Chairman  Stevens,  of 
the  New  York  Second  District  Public  Service  Commission,  attempts 
to  prove  the  contrary,  and  the  dissenting  opinion  of  Commissioner  Sague. 
3  N.Y.P.S.C.  2d  Dist.  286. 


THE  THEORY  OF  VALUATION  81 

resulting  therefrom  that  regulation  exists.  Fair  value  for 
rate  purposes,  therefore,  usually  destroys  existing  exchange 
value,  and  while  it  cannot  be  said  to  create  a  new  exchange 
value,  it  forms  the  basis  upon  which  one  will  be  created 
whenever  the  occasion  arises. 

Rate-making  value  differs  from  exchange  value  in  that 
it  deals  only  with  property  used  and  useful  in  rendering 
the  utility  service,  thus  excluding  many  elements  which 
enhance  the  value  of  the  property  for  exchange  purposes. 
Rate  value  cannot  even  be  said  to  be  the  exchange  value 
of  that  portion  of  the  property  valued.1 

The  reward  for  efficient  management,  which  is  a  legiti- 
mate element  in  exchange  value,  is  excluded  from  valua- 
tion for  rate-making  because  that  phase  of  regulation  is 
cared  for  by  adjustment  of  the  rate  of  return  allowed  on  the 
value  ascertained.  Going  value  as  a  separate  element  is  sim- 
ilarly denied,  for  aside  from  that  part  of  such  value  recog- 
nized either  as  development  expense,  the  physical  value  of 
services,  etc.,  or  reward  for  efficient  management,  it  has  no 
place  in  the  rate  basis  of  a  regulated  monopoly. 

V.  Valuation  for  Rate-Making 

The  determination  of  fair  value  as  an  element  of  public- 
utility  regulation  arose  in  rate  cases.  It  bears  the  plain 
stamp  of  its  origin.  Failure  to  realize  this  has  bred  confu- 
sion. Rate  valuation  is  distinctly  different  from  all  other 
valuation.  In  rate-making  the  value  sought  is  that  socialis- 
tic value  based  upon  cost  to  the  owner  in  the  way  of  toil  and 
sacrifice,  as  stated  by  Professor  Hadley.2  It  is  in  reality  the 
cost,  not  the  value,  of  the  utility  property  that  is  con- 

1  R.  L.  Hale  in  his  thesis  on  Valuation  and  Rate-Making,  p.  37,  suggest3 
that  the  Court  may  have  been  attempting  to  determine  the  exchange  ! 
value  of  a  part  of  the  property,  but  having  pointed  out  that  such  a  theory 
would  permit  only  of  rate  regulation  upward  he  concludes  that:  "It  is  not 
entirely  clear,  however,  that  the  Court  meant  by  '  fair  value '  the  exchange 
value  of  the  physical  property  (plus  the  franchise)."  Page  40. 

2  Hadley,  Economics,  sec.  105,  cited  above,  sec.  II. 


82  FAIR  VALUE 

sidered.  In  purchase  and  sale,  in  taxation,  in  condemnation 
in  government-purchase  cases,  property  value  of  one  sort 
or  another  is  determined.  But  this  is  not  true  of  rate 
valuation  in  so  far  as  property  is  concerned.  The  value  of 
the  service  is  in  question,  but  the  cost  and  not  the  value 
of  the  property  is  involved. 

Valuation  for  rate-making  purposes  is  a  purely  legal  con- 
cept. It  is  wholly  distinct  from  economic  valuation  in  gen- 
eral. Economics  recognizes  two  forms  of  valuation.  Where 
the  object  to  be  valued  is  freely  reproducible,  the  reproduc- 
tion cost  determines  the  value.  When  the  object  is  not  freely 
reproducible,  because  of  monopolistic  conditions,  skill  not 
to  be  duplicated,  etc.,  the  economic  value  is  determined  by 
capitalization  of  earnings.  If  economic  value  were  sought, 
public  utilities  would  be  valued  by  capitalizing  earnings, 
not  because  the  utilities  are  monopolistic,  or  operate  under 
a  franchise,  but  because  of  the  skill,  the  risk,  etc.,  entering 
into  their  construction.  It  is,  however,  to  avoid  exactly  this 
valuation  that  regulation  is  undertaken.  It  is  because  any 
substitute  for  competition  would  base  rates  on  this  valua- 
tion that  rate-making  must  be  considered  more  than  a 
substitute  for  competition. 

The  public  utility  is  not  in  the  same  category  as  other 
industries.  The  capitalized  earnings  test  cannot  be  applied 
because  it  results  in  the  vicious  circle  in  the  case  of  utilities. 
The  service  rendered  is  governmental.  Regulation  is  not 
restricted  to  the  prohibition  of  discrimination  and  refusal 
to  serve.  It  extends  to  rate  control.  The  public  has  an  inter- 
est in  the  profits.  The  private  property  is  altered  by  being 
subjected  to  a  serious  encumbrance.  It  is  absurd  to  argue 
that  the  encumbrance  does  not  change  the  value,  or  that 
the  public  interest  in  profits  requires  a  different  form  of 
valuation.  Economic  valuation  seeks  market  value  and 
market  value  cannot  be  determined  until  rate  value  is  fixed. 
A  true  understanding  of  "fair  value  for  rate-making  pur- 
poses," as  that  phrase  is  now  used,  can  be  gained  only  when 


THE  THEORY  OF  VALUATION  83 

the  distinct  legal  and  economic  status  of  private  property 
devoted  to  a  public  use  is  kept  clearly  in  mind.  The  differ- 
ence between  the  heavily  encumbered  value  of  private 
property  devoted  to  a  public  use,  and  the  non-freely  repro- 
ducible industrial  plant,  is  as  great  as  the  difference  be- 
tween such  a  plant  and  freely  reproducible  property.  The 
economic  theory  of  valuation  is  applicable  for  regulatory 
purpose  only  where  the  public  interest  in  profits  is  not 
involved  and  the  market  value  of  the  property  is  sought. 
The  aim  of  rate  regulation  is  to  subordinate  private  gain 
to  public  welfare;  to  prevent  the  utility  from  appropriating 
that  part  of  the  profit  which,  because  the  business  is  gov- 
ernmental, belongs  to  the  public  and  must  be  given  to  them 
by  way  of  better  service  or  lower  rates;  to  reduce  the  ex- 
change value  of  the  private  property  constituting  the  util- 
ity plant  and  equipment  by  reducing  rates,  below  the  figure 
they  would  take  in  the  absence  of  regulation,  to  a  sum  called 
the  reasonable  rate.  The  legal  rate  is  established  primarily 
to  benefit  the  public;  therefore,  it  cannot  be  above  the  com- 
mercial value  of  the  service.  It  must  be,  under  a  private- 
ownership  system,  a  rate  which  will  attract  capital,  and  not 
amount  to  confiscation;  therefore  it  cannot  be  below  the 
reasonable  cost  of  production  plus  a  fair  return.  Usually 
there  is  no  conflict  between  these  limits.  A  rate  to  produce 
a  fair  return  to  the  utility  need  not  be  above  the  fair  worth 
of  the  service  to  the  public,  unless  very  poor  judgment  has 
been  displayed  by  the  promoters.1 

1  The  constitutional  limitation  merely  states  whether  the  rate  can  be 
fixed  under  the  police  power  or  must  be  established  by  way  of  eminent  do- 
main with  just  compensation.  There  is  no  legal  prohibition  against  forcing 
rates  below  a  remunerative  point  where  conditions  demand  it.  The  primary 
obstacle  in  such  cases  is  the  necessity  of  operating  with  private  capital. 
The  commissions,  however,  have  not  hesitated  to  apply  the  limitation 
based  on  the  value  of  the  service  strictly  when  necessary.  Commissioner 
Shaw,  of  Illinois,  deals  with  the  situation  in  the  Ardmore  Water  Case, 
No.  4670,  thus:  Commissions  and  courts  "have  held  that  a  rate  for  utility 
service  must  be  fair,  alike  to  a  utility  and  the  public,  but  above  all  the  rate 
shall  not  exceed  the  value  of  the  service  rendered,  regardless  of  losses  which 


84  FAIR  VALUE 

It  has  been  universally  stated  that  the  test  of  rate  rea- 
sonableness is  dual,  and  that  the  two  elements  are  wholly- 
distinct,  even  antagonistic.  It  has  been  pointed  out  that  if 
the  limit  of  a  reasonable  rate  is  the  same  by  both  tests,  it 
is  but  a  coincidence;  that  there  is  far  more  likely  to  be  a 
zone  between  cost  of  service  plus  fair  return  and  worth  of 
service,  within  which  any  rate  fixed  will  be  reasonable 
tested  by  either  criterion.  Such  discussion  is  needlessly  con- 
fusing. Under  a  system  of  private  ownership  the  reasonable 
cost  of  service  and  the  worth  of  the  service  are  normally 

are  to  be  suffered  by  a  utility  which  may  inadvisably  have  installed  a 
plant  under  and  amidst  adverse  conditions  [quoting  from  and  citing  Graf- 
ton County  Electric  Light  &  Power  Co.  v.  N.  Hampshire;  Campbell  v. 
Hood  River  Gas  &  Elec.  Co.;  Bogart  v.  Wisconsin  Tel.  Co.;  In  re  Bound 
Brook  Water  Co.;  Oklahoma  Gin  Co.  v.  Oklahoma;  In  re  Bridgeport 
Natural  Gas  &  Oil  Co.;  Geer  v.  Baltimore  &  O.  R.R.  Co.;  In  re  Charles 
Town  Water  Co. ;  Butler  v.  Lewistown  A.  &  W.  St.  Ry.  Co. ;  In  re  Colorado 
Springs  Light,  Heat  &  Power  Co.;  Smyth  v.  Ames;  Simpson  v.  Shepard], 
although  the  petitioner  herein  has  prayed  that  this  commission  fix  water 
rates  for  the  village  of  Ardmore  based  upon  a  valuation  of  its  properties, 
such  rates  obviously  would  exceed  the  value  of  the  service;  and  this  com- 
mission cannot  find  such  rates  to  be  reasonable  in  this  particular  case." 
See  also  Brunswick  &  T.  W.  Dist.  v.  Maine  Water  Co.,  99  Me.  371;  "The 
Public  cannot  be  charged  more  than  the  service  is  worth,  regardless  of 
whether  the  gross  returns  received  from  such  rates  give  a  fair  return  upon 
the  reasonable  investment  or  not,  for  the  public  duty  which  the  company 
fundamentally  owes  its  customers  makes  obligatory  upon  it  the  rendering 
of  service  at  fair  rates  for  the  service  required  regardless  of  any  other  con- 
siderations," State  ex  rel.  R.R.  Comm.  v.  Seaboard  Air  Line  Ry.  Co.,  48 
Fla.  129,  37  So.  314.  In  the  Minnesota  Rate  Case  the  Supreme  Court  of  the 
United  States  forced  the  railway  to  carry  coal  at  a  rate  below  the  cost  of 
service,  and  in  Cotting  v.  The  Stock  Yards  a  dictum  recognizes  worth  of 
the  service  as  the  supreme  test  of  reasonableness.  Interstate  Commerce 
Comm.  v.  Chicago,  Gt.  Western  R.R.  Co.,  14  Fed.  1003;  Planters'  Com- 
press Co.  v.  Chicago,  C.  C.  &  St.  Louis  R.R.  Co.,  11  I.C.C.  382;  Planters' 
Compress  Co.  v.  Mo.  K  &T.  R.R.  Co.,  11  I.C.C.  606;  Memphis  Cotton 
Oil  Co.  v.  Rlinois  Central  R.R.  Co.,  17  I.C.C.  313;  National  Hay  Ass'n 
v.  Michigan  C.  R.R.  Co.,  19  I.C.C.  34;  In  re  Advance  on  Coal  to  Lake 
Ports,  22  I.C.C.  604;  Coke  Products  Ass'n  of  Connellsville  v.  Baltimore 
&  O.  R.R.  Co.,  27  I.C.C.  125;  etc.  There  is,  however,  a  line  of  cases  repre- 
sented by  Clyde  v.  Richmond  &  D.  R.R.  Co.,  57  Fed.  436,  which  hold  that 
worth  of  service  cannot  be  considered,  but  these  decisions  are  not  in  point, 
for  they  discuss  worth  of  the  service  to  the  individual  consumer,  not  to  the 
public. 


THE  THEORY  OF  VALUATION  85 

identical,  irrespective  of  how  widely  actual  cost  differs  from 
the  worth  of  service.  The  only  time  the  worth  of  the  service 
can  fall  below  the  cost,  using  the  term  "cost"  as  justifiable 
or  reasonable  cost,  is  when  a  service  is  rendered  in  a  com- 
munity too  small  or  too  poor  to  afford  such  service.  Private 
ownership  attempting  to  support  itself  on  the  return  from 
rates  has  no  place  under  such  circumstances.  Government 
ownership,  subsidized  private  operation,  or  abandonment 
of  service  is  imperative.  Where  the  conflict  is  apparent 
rather  than  real,  and  results  from  poor  judgment  or  bad 
management,  the  situation  can  be  remedied  by  compelling 
the  utility  to  make  actual  cost  of  service  correspond  to  the 
reasonable  cost. 

Value  of  service,  being  synonymous  with  reasonable  cost 
of  service,  may  be  disregarded  without  endangering  the 
public  interest  it  protects.  We  are,  therefore,  concerned 
solely  with  the  determination  of  cost.  But  the  cost  we  deal 
with  is  the  reasonable  not  the  actual  cost;  otherwise  the 
value  and  cost  of  service  are  not  equivalent  and  the  former 
must  prevail,  for  it  represents  the  social  interest  and  is  su- 
perior to  private  rights  which  themselves  exist  only  to  pro- 
mote the  public  welfare. 

Under  competitive  conditions  the  rate  tends  to  approx- 
imate the  cost  of  service.  Capital  flows  freely  into  the  util- 
ity field  at  this  figure.  Regulation  eliminates  the  risk  due 
to  competition,  and  allows  the  savings  available  through 
monopolistic  production  and  rewards  efficient  manage- 
ment. The  utility  can  have  no  cause  for  complaint,  there- 
fore, when  the  rate-making  body  adopts  cost  of  service  as 
the  basis  for  charges.  What  constitutes  "cost  of  service"  is 
the  prime  question. 

Cost  of  service  might  be  considered  from  either  of  two 
angles,  that  of  private  interest  and  that  of  the  public  inter- 
est. The  former  would  be  the  proper  viewpoint  under  the 
laissez-faire  system,  upon  which  our  economic  theories  are 
almost  wholly  based.  The  latter  is  the  only  rational  stand 


86  FAIR  VALUE 

when  such  a  system  has  been  abandoned  and  regulation  in- 
stituted. The  fundamental  economic  rules  cannot  be  dis- 
regarded, but,  on  the  other  hand,  economic  principles  based 
upon  a  laissez-faire  policy  must  be  disregarded.  The  public 
interest  must  predominate,  for  the  private  rights  exist 
only  to  promote  the  public  welfare.  We  approach  the  cost 
question,  therefore,  with  an  intent  to  promote  the  public 
good,  even  at  the  expense  of  private  rights.  We  recognize 
but  two  limitations  upon  this  purpose,  that  imposed  by  the 
Fourteenth  Amendment,  which  provides  that  beyond  the 
point  at  which  rate-making  takes  instead  of  restrains,  reg- 
ulation must  proceed  under  the  power  of  eminent  domain 
instead  of  the  police  power;  and  that  dictated  by  the  neces- 
sity of  attracting  capital  or  abandoning  private  opera- 
tion. 

So  long  as  the  State  remains  committed  to  private  owner- 
ship, it  may  well  be  considered  estopped  from  asserting  that 
public  interest  extends  further  than  the  point  which  will 
promote  such  a  system.  So  long  as  private  ownership  is  ac- 
cepted, the  State  will  be  effectively  prevented  from  assert- 
ing a  public  interest  which  will  preclude  the  steady  flow  of 
capital  into  the  utility  field.  The  cost  of  service  involved  is, 
therefore,  one  which  will  be  fair  to  the  investor. 

The  investor's  chief  interest  is  the  securing  of  a  steady 
return  upon  his  investment  proportionate  to  the  risk  as- 
sumed. The  aim  of  regulation  is  to  minimize  that  risk,  thus 
reducing  the  rate  of  return,  and  to  see  that  only  the  actual 
investment  receives  a  return.  "Valuation"  is  the  determi- 
nation of  the  amount  of  that  part  of  the  investment  used 
and  useful  in  the  service  and  represented  by  plant  and 
equipment. 

Valuation  for  rate-making  is  a  determination  of  invest- 
ment, not  of  worth  or  value.  It  asks  what  sum  did  the  in- 
vestors put  into  the  property;  what  did  it  cost  them,  not 
what  can  they  sell  it  for.  The  aim  is  to  attract  capital  at  the 
lowest  figure  possible,  and  capital  will  be  attracted  as  long 


THE  THEORY  OF  VALUATION  87 

as  a  fair  return  is  allowed  upon  the  actual  present  invest- 
ment. 

The  utility  company  exercises  a  public  function.  It  must 
be  satisfied  with  a  limited  return  upon  its  investment  and 
must  permit  what  would  otherwise  be  the  speculative  prof- 
its from  the  business  to  go  to  the  general  public  by  way  of 
reduced  rates  and  better  service.  The  interest  of  the  public 
in  excess  profits  over  a  fair  return  is  as  absolute,  under  the 
present  legal  system,  as  the  property  rights  of  the  inves- 
tors. Any  method  of  final  valuation  which  grants  the  utility 
a  return  upon  a  larger  sum  than  that  actually  invested  takes 
the  property  right  of  the  public  for  the  benefit  of  the  utility 
stockholder  just  as  surely  as  unreasonable  rate-making 
takes  utility  property. 

The  private  property  voluntarily  devoted  to  the  public 
use  by  the  utility  operator,  in  the  eyes  of  the  law,  is  in- 
vested with  the  understanding  that  it  is  being  subjected  to 
regulation.  The  restriction  is  stated  in  the  common  law.  It 
was  stated  when  the  utility  company  was  organized  and 
was  a  part  of  the  law,  knowledge  of  which  is  required  of  all. 
The  investor  or  bondholder  who  disregarded  the  legal  pro- 
vision has  only  his  own  carelessness  or  gambling  instinct  to 
blame  when  losses  follow  his  laches.  The  fact  that  in  reality 
the  investment  may  have  been  made  with  the  knowledge 
that  an  unreasonable  return  could  be  secured  only  gives  in- 
centive to  enforce  the  strict  legal  rule  with  more  rigor.  The 
law  remains  the  same.  Irrespective  of  what  profit  the  com- 
pany has  actually  made,  all  it  was  entitled  to  after  under- 
taking the  public  service  was  a  reasonable  return  upon  its 
actual  investment  —  not  such  return  as  it  could  secure  in  a 
more  hazardous  business  —  not  such  return  as  it  might  gain 
by  putting  its  money  out  at  interest,  or  by  speculating  in 
real  estate;  but  such  return  as  it  could  reasonably  exact 
from  the  public  for  the  utility  service  rendered. 

Any  form  of  final  valuation  not  based  directly  upon  the 
actual  reasonable  present  investment  must  inevitably  fail 


88  FAIR  VALUE 

to  meet  the  two  principal  requirements  of  regulation.  It 
cannot  create  a  regulatory  force  which  will  keep  rates  near 
the  reasonable  cost  of  production,  and  it  will  encourage 
rather  than  stamp  out  speculation. 

The  aim  of  rate-making  valuation  is  the  determination  of 
the  actual  unimpaired  investment  reasonably  necessary  for 
the  utility  service  rendered. 

VI.  Valuation  for  Purchase  and  Sale 

Valuation  for  purposes  of  purchase  and  sale  differs  es- 
sentially from  that  for  rate-making.1  In  determining  a  value 
for  rate-making  purposes  the  public  interest  is  directly  and 
vitally  involved.  Such  valuation  must  be  based  directly 
upon  tangible  or  intangible  property  values  contributing  to 
the  public  service.  It  must  be  an  equitable  figure  as  between 
the  public  and  the  utility.  Valuation  for  purchase  and  sale, 
however,  does  not  affect  the  public  interest  so  vitally.  The 
chief  concern  of  regulation  in  such  cases  is  to  make  certain 
that  the  property  is  not  so  crippled  by  indebtedness  and 
fixed  charges  as  seriously  to  handicap  service.  The  pur- 

1  "  In  valuing  utilities  for  the  purpose  of  condemnation  and  purchase, 
many  elements  must  often  be  taken  into  account  which  should  not  be 
given  any  consideration  in  valuations  made  for  the  purpose  of  rate-mak- 
ing," Re  Manitowoc  Water  Works  Co.,  7  W.R.C.R.  71,  72.  See  also  Osh- 
kosh  Waterworks  Co.  v.  Railroad  Comm.  (Wis.  Sup.  Ct.)  P.U.R.  1915-D- 
336;  see  Paper  of  Comm.  Thelen  before  Nat.  Ass'n  of  Ry.  Commission- 
ers, Oct.  30,  1913;  Re  Tyrone  Electric  Co.  (111.)  P.U.R.  1916-E-708;  In 
re  Stark  County  Power  Co.  (111.)  P.U.C.  No.  6704,  6705;  Re  Crownover 
Tel.  Co.  (Neb.)  P.U.R.  1915-E-571;  Commercial  Club  v.  Missouri  P. 
Utilities  Co.  (Mo.)  P.U.R.  1815-C-1017;  Queens  Borough  Gas  &Elec.  Co., 
2  P.S.C.  1st  Dist.  (N.Y.)  544;  Mayhew  v.  King's  County  Lighting  Co., 
2  P.S.C.  1st  Dist.  (N.Y.)  659;  Fuhrmann  v.  Cataract  Power  &  Conduit 
Co.,  3  P.S.C.  2d  Dist.  (N.Y.)  656;  Pub.  Serv.  Gas  Co.  v.  Bd.  of  P.  Util. 
Comm'rs.  (N.Y.  Sup.  Ct.)  87  Atl.  651;  Willcox  v.  Consolidated  Gas  Co., 
212  U.S.  19,  29  Sup.  Ct.  192,  53  L.  ed.  382;  Omaha  v.  Omaha  Water  Co., 
218  U.S.  180, 54  L.  ed.  991,  30  Sup.  Ct.  615;  Ames  v.  Union  Pacific  Ry.  Co., 
64  Fed.  165;  Spring  Valley  Water  Works  v.  San  Francisco,  192  Fed.  137; 
etc.  There  were,  however,  early  cases  in  which  rate-making  and  purchase- 
and-sale  value  were  held  identical.  Spring  Valley  Water  Works  v.  City  of 
San  Francisco,  124  Fed.  574;  etc. 


THE  THEORY  OF  VALUATION  89 

chaser  and  seller  are  the  parties  primarily  concerned.  The 
seller  is  interested  in  securing  the  full  value  of  his  property, 
on  the  basis  of  what  it  has  been  worth  to  him  as  an  income 
producer.  He  must  base  his  price  upon  the  revenues  he  has 
received  in  the  past  and  the  outlook  for  the  future.  The  pur- 
chaser aims  to  pay  no  greater  sum  than  he  believes  the 
property  will  be  worth  to  him  as  an  income  producer.  He 
bases  his  offer  on  the  revenues  receivable  from  the  prop- 
erty and  his  hope  for  developing  the  income  in  the  future. 
Both  seller  and  purchaser  are  controlled  by  the  physical 
condition  of  the  property  and  its  effect  upon  future  ex- 
penditures for  maintenance,  and  for  additions  and  better- 
ments. Both  parties  must  be  governed  to  a  large  extent 
by  the  rate-making  value  of  the  property,  since  it  limits 
the  future  return.  The  price  must  be  fixed  at  approxi- 
mately the  physical  value  of  the  property,  for  rate  regula- 
tion will  prevent  the  earning  of  income  on  a  value  in  excess 
of  that  figure. 

Conditions  may  exist,  however,  under  which  the  pur- 
chaser feels  justified  in  paying  an  amount  in  excess  of  the 
rate-making  value  of  the  property.  The  previous  operation 
of  the  property  may  have  been  so  uneconomical  as  to  leave 
room  for  return  from  increased  efficiency.  There  may  be  a 
fair  prospect  of  increasing  net  return  by  rendering  a  better 
service  at  reduced  rates,  thus  preventing  public  criticism  of 
rates  until  there  has  been  time  to  recoup  the  difference 
between  the  amount  paid  and  the  physical  value  of  the 
property.1 

The  interest  of  the  public  in  a  purchase  and  sale  case  is 
that  rates  shall  not  be  made  excessive  to  pay  a  return  upon 
a  price  above  that  of  the  rate-making  value,  that  service 
shall  not  be  interfered  with,  and  that  the  company  shall 
not  be  thrown  into  financial  difficulties  by  reason  of  ex- 
cessive capitalization  on  which  only  a  small  dividend  may 
be  earned.  The  utility  cannot,  therefore,  be  allowed  in  a 
1  See  Re  Stark  County  Tel.  Co.,  5  I.P.U.C.  63;  etc. 


90  FAIR  VALUE 

purchase-and-sale  case,  to  build  up  a  capital  account  ma- 
terially in  excess  of  the  rate-making  value  of  the  property, 
or  to  issue  securities  in  excess  of  that  figure.  Justice  to  the 
stockholder  demands  that  the  capital  be  restricted  to  ap- 
proximately the  rate  basis.  Justice  to  the  public  demands 
that  the  utility  be  placed  on  a  sound  financial  basis.  A  pur- 
chase-and-sale price  may  be  authorized  in  excess  of  the 
rate  value  of  the  property  but  the  excess  must  be  charged  to 
profit  and  loss  or  amortized  from  income. 

VII.  The  Methods  of  Valuation 

When  valuation  was  first  suggested  as  a  test  for  the  rea- 
sonableness of  rates,  to  determine  when  the  exercise  of  the 
State  police  power  shaded  off  into  the  function  of  eminent 
domain,  the  valuation  suggested  was  the  outstanding  capi- 
talization. This  was  natural  because  dividends  were  divided 
upon  the  basis  of  capitalization  and  it  was  the  dividend- 
earning  power  which  seemed  to  be  in  question.  The  utilities 
favored  such  valuation  because  a  majority  of  them  were 
capitalized  in  excess  of  actual  investment  and  any  other 
basis  would  mean  a  reduced  dividend.  It  was  not,  however, 
a  natural  stand  for  the  courts,  even  on  an  appeal  for  protec- 
tion of  property  rights,  and  capitalization  as  a  basis  for 
valuation  has  been  consistently  rejected  from  the  start.1 

The  market  value  of  the  outstanding  securities  was  next 
advocated,  but  was  repudiated  as  a  valuation  basis  for  the 
same  reasons  that  discredited  capitalization,  i.e.,  neither 
capital  stock  nor  bonds  necessarily  represented  moneys 
actually  invested  or  funds  used  in  rendering  the  service,  and 
therefore  could  not  be  made  the  basis  for  determination  of 
the  cost  of  service.  The  market  value  of  securities  is  based 
in  part  upon  property  not  devoted  to  the  public  service  and 
other  elements  of  value  not  admissible  in  a  valuation  for 

1  169  U.S.  466;  see  argument  of  W.  J.  Bryan  (p.  489)  for  the  contention 
of  the  carriers;  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1;  Cotting  V. 
Kansas  City  Stockyards  Co..  82  Fed.  850;  etc. 


THE  THEORY  OF  VALUATION  91 

regulatory  purposes.  Market  value,  too,  is  based  largely 
upon  return  on  the  investment  and  thus  upon  rates.  Rates 
being  the  element  involved  the  rate-making  value  would 
have  to  be  determined  before  the  market  value  of  the  secu- 
rities to  make  a  reduction  of  rates  possible  —  market  value 
involves  existing  rates  —  rate-making  value  is  concerned 
with  reasonable  rates. 

The  market  value  of  the  securities  is  an  unacceptable 
valuation  basis,  too,  because  it  is  readily  susceptible  to 
manipulation.  It  is  inherently  unfitted  for  regulatory  pur- 
poses because  it  would  prevent  the  elimination  of  specu- 
lation. 

The  early  decisions,  realizing  the  defects  of  capitaliza- 
tion and  market  value  of  securities,  seemed  to  assume  that 
original  cost  must  be  accepted  as  the  measure  of  value  for 
regulatory  purposes.  For  this  reason,  they  all  sound  a  warn- 
ing against  confusing  cost  and  book  value.  Original  cost 
must  not  be  misdirected  to  include  the  fallacies  of  the  dis- 
carded theories.  The  public  needs  protection  from  a  utility 
which  has  become  so  powerful  that  regulation  has  been  ren- 
dered necessary.  Original  cost,  or  actual  capital  investment, 
the  Court  hastens  to  point  out,  cannot  be  determined  from 
the  books  of  the  company  alone.  To  base  original  cost  solely 
on  book  value  would  be  to  read  into  it  all  the  fallacies  of 
valuation  based  on  capitalization.  It  would  permit  the  util- 
ity company  to  direct  its  own  regulation  and  wholly  destroy 
the  value  of  government  control.  An  estimate  of  the  origi- 
nal cost,  the  Court  admits,  however,  may  be  made  from  the 
company's  records.  The  inventory  may  be  based  upon  the 
facts  there  shown.  But  the  figures  thus  gained  cannot  be 
accepted  as  the  sole  basis  for  a  final  valuation.  Actual  prac- 
tice showed  that  the  company's  book  entries  of  expendi- 
tures must  be  checked  to  render  the  estimate  allowed  by 
the  Court  a  safe  one  for  the  public.  To  make  such  a  check  an 
inventory  of  the  property  on  some  basis  other  than  the 
company's  record  was  required.  To  verify  that  record  with 


92  FAIR  VALUE 

current  prices  at  the  time  of  construction,  to  check  back  on 
every  stage  of  the  company's  development,  seemed  to  ren- 
der the  check  a  more  tedious  and  complicated  process  than 
the  inventory  itself.  A  reproduction-cost  appraisal  was  sug- 
gested as  a  less  troublesome  check.1  The  courts  accepted  the 
suggestion,  and  the  new  appraisal  thus  introduced  has  been 
retained  for  other  reasons. 

Two  forms  of  appraisal  valuation  have  been  developed, 
original  cost  to  date  and  reproduction  cost.  Detailed  con- 
sideration of  their  application  is  reserved  for  the  following 
chapter. 

VIII.  Summary 

The  conclusion  naturally  reached  is  that  the  term  "fair 
value, "  if  used  without  qualification  as  to  its  application, 
is  practically  impossible  of  specific  definition.  Fair  value  for 
rate-making  purposes  differs  from  that  for  purchase  and 
sale,  and  both  differ  from  strict  exchange  value.  No  form  of 
value  for  regulatory  purposes  is  the  exact  equivalent  of 
economic  or  exchange  value.  Value  for  condemnation  pro- 
ceedings is  the  nearest  approach  to  that  figure.  Exchange 
value  considers  only  private  interests.  Regulatory  valua- 
tion involves  the  public  interest.  It  is  in  the  nature  of  an 
accounting  between  the  utility  and  the  public  and  excludes 
the  public  interest  in  the  property  which  commercial  or 
economic  value  includes.  Regulation  limits  or  depreciates 
exchange  value.  Valuation  as  a  basis  for  purchase-and-sale 
cases  permits  of  the  consideration  of  capitalized  earnings, 
and  otherwise  resembles  exchange  value,  but  it  is  mate- 
rially restricted  by  the  necessity  of  keeping  the  purchase 
price  near  the  fair  value  for  rate-making.  Rate  valuation 
exercises  an  indirect  control  over  all  other  phases  of  regu- 
lation. It  is,  therefore,  the  fair  value  for  rate-making  pur- 
poses with  which  we  are  chiefly  concerned. 

The  aim  of  rate  regulation  is  to  determine  a  rate  base 
1  See  infra,  Chapter  V,  Sec.  III. 


THE  THEORY  OF  VALUATION  93 

which  will  permit  the  fixing  of  rates  which  will  not  exceed 
the  value  of  the  service  and  yet  be  high  enough  to  attract 
private  capital  to  the  utility  field  and  fall  within  the  limita- 
tion placed  upon  the  police  power  by  the  due  process  clause 
of  the  Fourteenth  Amendment.  The  reasonable  cost  of  the 
service  ordinarily  affords  such  a  base.  Rate-making  valua- 
tion is  a  part  of  cost-of -service  determination.  It  seeks  to 
establish  the  investment  upon  which  a  return  must  be 
earned.  It  deals  with  investment  and  cost,  not  with  value 
as  that  term  is  commonly  understood.  It  deals  with  normal 
or  reasonable,  not  actual  investment. 

Two  principal  methods  of  estimating  reasonable  invest- 
ment have  been  developed.  They  are  the  original-cost  and 
the  reproduction-cost  appraisal. ,< 


CHAPTER  V 
VALUATION  METHODS 

I.  The  Inventory 

It  is  the  purpose  of  valuation  to  fix  a  basis  for  rate-mak- 
ing, sale  price,  purchase  price,  taxation,  reorganization, 
and  security  issues  —  a  basis  which  will  protect  the  public 
interest,  induce  capital  to  enter  the  utility  field,  and  keep 
regulation  within  the  limits  fixed  by  the  Fourteenth 
Amendment.  How  that  basis  is  to  be  found  remains  to  be 
considered. 

There  are  three  distinct  steps  in  valuation  —  the  making 
of  the  inventory,  the  determination  of  elements  of  value 
properly  considered  in  view  of  the  specific  purpose  of  the 
appraisal,  and  the  final  determination  of  value.  Much  con- 
fusion in  valuation  has  resulted  from  unwillingness  to  recog- 
nize this  division.  The  engineer,  all-sufficient  unto  himself, 
selects  the  items  he  will  emphasize,  makes  his  inventory, 
adds  a  finding  of  value,  and  submits  the  two  as  one,  sup- 
ported by  a  brief  under  the  guise  of  a  report.  Writers  dis- 
cuss inventory,  appraisal,  and  valuation  as  synonymous. 
And  the  courts  have  fallen  into  the  same  error. 

The  first,  and  only  the  first,  step  is  the  sphere  of  the 
engineer  and  accountant.  The  second  step  demands  the 
knowledge  of  the  economist,  and  the  third  is  the  province 
of  commission  and  court. 

The  inventory  lists  in  detail  the  tangible  and  intangible 
property  of  the  utility;  the  appraisal  assigns  a  unit  value  to 
each  article  listed.  That  value  is  determined  by  the  theory 
of  appraisal  irrespective  of  its  effect  upon  the  final  valua- 
tion or  fair  value  for  the  specific  purpose  of  the  case.  Next 
the  average  life,  age,  and  condition  of  each  item  is  stated  to 
show  the  depreciated  value.  Here  the  appraisal  technically 
stops,  but  it  is  always  accompanied  by  a  history  of  the 


VALUATION  METHODS  95 

property.  An  accurate  account  of  the  organization,  financ- 
ing, and  development  of  the  corporation  is  essential  to  a 
fair  inventory  of  intangible  property. 

The  total  of  the  values  shown  by  the  inventory  and  ap- 
praisal, irrespective  of  the  theory  of  valuation  used,  does 
not  fix  the  value  of  the  property,  even  though  the  property 
be  listed  at  its  depreciated  worth.  The  appraisal  shows  all 
existing  values  regardless  of  their  admissibility  for  rate  or 
sale  purposes.  It  includes  property  not  used  or  useful  in 
rendering  the  public  service,  expenditures  injudiciously 
made,  and  numerous  other  factors  which  cannot  always  be 
considered  in  the  final  valuation.  Its  total  is  a  figure  which 
may  be  just  neither  to  the  public  nor  to  the  company. 

The  appraisal  is  not  concerned  with  fair  value  nor  worth 
of  service.  It  is  the  engineer's  or  accountant's  statement  of 
the  exact  present  condition,  character,  and  amount  of  the 
tangible  and  intangible  property,  the  actual  or  estimated 
original  or  reproduction  cost  of  each  item  thereof.  It  should 
follow  consistently  the  form  of  valuation  selected,  or  draw 
separate  inventories  upon  each  basis  if  more  than  one  is 
employed.  It  should  represent  the  appraiser's  best  estimate 
of  the  value  of  each  item,  without  regard  to  the  purpose  of 
the  valuation. 

The  work  of  the  economist  begins  when  the  appraisal  is 
completed.  It  is  his  duty  to  consider  the  items  of  value  ap- 
praised and  determine  which  are  to  be  considered  for  the 
particular  purposes  of  the  proceeding.  That  decision,  once 
rendered,  formulates  a  rule  applicable  in  all  similar  cases. 
Any  element  of  value  properly  considered  in  one  rate  case 
is  relevant  in  any  other,  irrespective  of  whether  it  is  allowed 
as  a  part  of  the  final  valuation  in  the  particular  case.  Any 
element  of  value  properly  held  irrelevant  in  one  rate  case 
should  not  receive  consideration  in  another.  The  statement 
that  "fair  value  cannot  be  found  by  formula"1  refers  ex- 

1  Springfield  v.  Springfield  G.  &  E.  Co.,  I.P.U.C.  No.  2138;  Lincoln  a 
Lincoln  Water  &  Light  Co.,  I.P.U.C.  No.  2496;  P.U.R.  1917-B-l;  In  re 
Berlin  Elec.  Light  Co.,  3  N.H.  P.S.C.  174;  etc. 


96  FAIR  VALUE 

clusively  to  the  final  valuation.  It  does  not  imply  that  fixed 
rules  cannot  be  formulated  relative  to  the  elements  of  value 
properly  considered  or  excluded  for  rate  or  sale  purposes. 
It  merely  means  that  these  rules,  though  they  determine 
what  general  elements  of  value  are  relevant  for  each  type  of 
valuation,  do  not  assure  such  items  of  consideration  in  the 
final  valuation  in  each  case.  This  is  a  limitation  true  of  all 
exclusion  rules  of  evidence.  It  is  true  in  valuation  cases,  be- 
cause, for  example,  though  engineering  and  legal  expenses 
are  proper  elements  of  value  in  the  inventory,  they  may  be 
excluded  from  the  final  valuation  because  they  were  never 
incurred,  because  improperly  incurred  or  incorrectly  in- 
ventoried. Some  elements  of  value,  on  the  other  hand,  are 
not  properly  considered  in  any  rate  case.  Property  not 
used  or  useful  in  the  public  service,  excessive  franchise 
values,  etc.,  must  always  be  excluded. 

The  determination  of  which  of  the  elements  inventoried 
by  the  appraiser  and  branded  admissible  by  economic  rule 
shall  be  taken  into  consideration  in  the  particular  case  is 
the  work  of  the  commission  and  court.  That  decision  con- 
stitutes the  valuation  of  the  property. 

Valuation  can  be  clearly  understood  only  by  considering 
the  two  principal  theories  of  valuation  separately,  and  keep- 
ing in  mind  that  these  theories  are  used  in  two  wholly  dis- 
tinct and  unconnected  ways,  (1)  in  the  valuation  of  the 
separate  items  of  the  inventory,  (2)  as  the  theory  of  final 
valuation.  In  actual  practice  an  appraisal  based  on  only 
one  of  these  theories  has  seldom  determined  the  final  valua- 
tion, unless  the  peculiar  circumstances  of  the  particular 
case  made  such  action  unavoidable.  The  general  rule  has 
been  to  accept  appraisals  based  on  original  and  reproduc- 
tion cost  respectively,  made  without  regard  to  their  effect 
upon  the  final  valuation;  to  determine  from  them  the  more 
equitable  cost  under  the  circumstances,  to  eliminate  the 
elements  of  value  not  relevant  in  the  special  case,  and  then 
depreciate  the  sum  thus  decided  upon. 


VALUATION  METHODS  97 

II.  The  Original-Cost  Theory 

The  first  theory  of  value  favorably  considered  by  the 
courts  was  the  original  cost  of  the  property.  Like  most  valu- 
ation terms  "original  cost"  has  been  employed  with  innu- 
merable meanings,  being  twisted  to  suit  the  convenience  of 
the  person  making  the  appraisal,  of  the  attorney,  and  un- 
fortunately even  of  the  courts.  This  jumbling  of  words  has 
resulted  in  the  adoption  of  substitute  terms  and  the  draw- 
ing of  unnecessary  technical  distinctions.  The  confusion  is 
inexcusable,  and  bears  every  mark  of  a  deliberate  attempt 
by  designing  utility  representatives  to  render  the  original- 
cost  theory  so  indefinite  and  ambiguous  that  its  applica- 
tion must  produce  unreasonable  results,  and  be  frowned 
upon  by  the  courts.1 

Original  cost,  as  a  basis  for  final  valuation,  has  been  dis- 
tinguished from  both  actual  cost  and  book  value.  The  three 
terms  would  be  synonymous  under  a  proper  system  of  ac- 
counting. None  of  them  are  fitted  to  describe  what  original 
cost  means.  Confusion  has  resulted,  also,  from  the  use  of 
the  term  to  indicate  either  actual  original  investment  alone, 
or  such  investment  plus  betterments  properly  chargeable 
to  the  capital  account. 

The  narrow  use  of  the  term  was  forced  upon  the  courts 
by  short-sighted  public  representatives  in  the  early  cases  in 
an  attempt  to  exclude  all  betterments.  The  necessity  of  at- 
tracting private  capital  for  future  improvements,  and  the 
certainty  of  court  intervention  on  constitutional  grounds, 
were  overlooked.  Utility  attorneys,  knowing  that  such  an 
interpretation  would  destroy  original  cost,  readily  assented 
to  it,  and  hastened  to  point  out  that,  as  thus  used,  it  was  an 
improper  basis  even  for  an  appraisal. 

A  careful  consideration  of  the  literature  of  valuation,  the 

1  This  phase  of  the  question  is  illustrated  by  the  voluminous,  and 
ludicrous,  if  serious,  brief  filed  for  the  carriers  before  the  Interstate 
Commerce  Commission,  August  1,  1917,  in  the  valuation  of  the  Texas 
Midland  R.R.  Co. 


98  FAIR  VALUE 

briefs  of  attorneys,  the  reports  of  engineers,  and  court  opin- 
ions leads  to  the  conclusion  that  original  cost  is  now  univer- 
sally construed  as  original  cost  to  date.  It  includes  all  ex- 
penditures made  in  the  original  construction  of  the  plant 
and  all  additions  and  betterments  chargeable  to  the  capital 
account  under  recognized  accounting  methods.  It  excludes 
all  expenditures  for  replacements  made  necessary  by  de- 
preciation, obsolescence,  or  inadequacy.  It  corresponds  to 
neither  actual  cost  nor  book  value.  It  is  the  original  invest- 
ment to  date,  using  the  word  "original"  to  exclude  re- 
placements. 

Any  theory  of  original  cost  which  failed  to  consider  addi- 
tions and  betterments  would  render  a  valuation  for  rate- 
making  powerless  to  serve  the  purpose  for  which  it  was  un- 
dertaken. The  rate-basis  valuation  is  made  to  determine  the 
cost  of  service  irrespective  of  its  value.  The  valuation  must 
be  fair  to  the  public,  but  public  interests  are  ordinarily  pro- 
tected by  basing  rates  on  reasonable  cost  of  service,  and 
where  such  is  not  the  case  they  must  depend  upon  the 
wholly  distinct  limitation,  worth  of  service.  If  rates  must 
be  fixed  below  the  cost  of  service  to  keep  them  within  the 
value  of  the  service,  the  action  must  be  taken  in  spite  of  the 
valuation,  not  by  alteration  of  it.  The  questions  valuation 
deals  with  are,  What  is  the  investment  upon  which  a  return 
must  be  allowed  in  order  to  attract  capital?  and,  What  is 
the  extent  of  the  property  rights  protected  by  the  Four- 
teenth Amendment?  The  exclusion  of  expenditures  for 
reasonable  additions  and  betterments  would  take  private 
property  without  compensation  and  drive  capital  from 
the  utility  field. 

The  original  cost  to  date  indicates  the  property  to  be 
included  in  the  inventory  and  the  unit  value;  but  an  ap- 
praisal made  on  that  basis  does  not  necessarily  represent 
the  final  value  of  the  property.  The  inventory  may  include 
items  not  used  or  useful  in  the  public  service,  improper 
expenditures,  etc.,  and  irrespective  of  the  appraisal  basis 


VALUATION  METHODS  99 

the  property  must  be  depreciated  to  arrive  at  present 
value.1 

The  California  Commission  defines  original  cost  as  the 
actual  expenditures  for  operative  property  in  cash  or  equiv- 
alent in  terms  of  cash,  chargeable  to  capital  in  accordance 
with  the  Interstate  Commerce  Commission's  classification 
as  of  the  date  of  valuation.2 

The  term  is  used  by  the  Public  Utilities  Commission 
of  Illinois  to  mean  the  actual  expenditures,  in  cash  (or  its 
equivalent  in  terms  of  cash),  made  by  the  utility  for  used 
and  useful  property  which  is  properly  chargeable  to  capital 
account  and  which  is  embraced  in  an  inventory;  or,  in  the 
absence  of  records  and  books  of  accounts  showing  the  actual 
expenditures,  then,  the  estimated  cost  of  the  property  as  of 
the  sundry  dates  of  the  installations  of  the  various  property 
items  is  considered  the  original  cost  thereof.3 

III.  The  Reproduction-Cost  Theory 

A  second  theory  of  valuation,  reproduction  cost,  made 
its  appearance  in  the  Supreme  Court  decision  in  Reagan  v. 
The  Farmers'  Loan  and  Trust  Company,4  where  the  Court 

1  The  term  "original  cost"  has  not  been  defined  by  the  Federal  Su- 
preme Court  and  has  seldom  been  explained  by  the  lower  courts.  Com- 
missioner Halford  Erickson,  of  Wisconsin,  in  the  Utilities  Magazine,  vol.  i, 
No.  3,  p.  13,  says:  "By  original  cost  in  this  connection  it  seems  to  me 
should  be  understood  the  cost  at  which  the  existing  property  used  by  pub- 
lic utilities  in  rendering  service  was  acquired.  By  cost  of  reproduction  is 
meant  the  cost  of  reproducing  the  existing  property  under  prevailing  con- 
ditions. The  original  cost  of  the  existing  property  should  be  shown  by  the 
books  and  records  of  the  utilities  providing  these  have  been  properly  kept 
and  are  still  in  existence.  When  the  books  have  not  been  so  kept  or  are  not 
available,  the  original  cost  as  thus  outlined  may  be  determined  very  much 
in  the  same  manner  as  that  in  which  the  cost  of  reproduction  is  found." 
Quoted  with  approval  in  City  of  Springfield  v.  Springfield  Gas  and  Elec- 
tric Co.  (111.)  P.U.R.  1916-C-281;  and  City  of  Lincoln  v.  Lincoln  Water 
and  Light  Co.  (111.)  P.U.R.  1917-B-l. 

2  In  re  Sugar  Pine  R.R.  Co.  (Cal.)  P.U.R.  1915-A-728;  see  also  Annual 
Rept.  Cal.  R.R.  Comm.  1915-16. 

3  Third  Annual  Rep.  Illinois  Public  Utilities  Comm.,  p.  93. 

4  154.  U.S.  362,  14  Sup.  Ct.  180,  38  L.  ed.  1014. 


100  FAIR  VALUE 

considered  the  showing  that  the  railroad  property  under 
consideration  had  cost  $40,000,000  and  could  not  be  re- 
placed for  less  than  $25,000,000,  and  pointed  out  that  be- 
cause of  extravagance,  waste  in  management,  enormous 
salaries,  and  because  "the  construction  may  have  been  at  a 
time  when  material  and  labor  were  at  the  highest  price, 
'actual  cost'  may  have  exceeded  the  'present  value. '  " 

The  reference  to  reproduction  cost  in  this  decision  and 
"present  cost  of  construction"  in  the  Ames  Case  was  seized 
upon  by  utility  attorneys  and  developed  in  this  or  that 
direction  as  the  advocate  thought  he  could  best  serve  his 
client.  The  Court  itself  did  not  define  the  terms  used.  The 
attempt  to  define  them  since  have  been  many  and  varied. 
They  have  developed  along  three  general  lines:  (1)  the  cost 
of  reproducing  a  plant,  similar  in  all  essentials  to  the  exist- 
ing plant,  under  present  conditions;  (2)  the  cost  of  repro- 
ducing a  similar  plant  at  present  prices,  under  conditions 
prevailing  at  the  time  of  original  construction;  (3)  the  cost 
of  constructing  a  substitute  plant  capable  of  performing 
the  same  service.  "Cost  of  reproduction  new  less  depreci- 
ation," sometimes  spoken  of  as  a  fourth  form  of  the  theory, 
is  but  the  application  of  depreciation  rules  to  the  in- 
ventory. 

IV.  Development  of  the  Reproduction  Theory 

The  determination  of  what  the  term  "reproduction 
cost"  means,  requires  consideration  of  the  development  of 
the  theory  and  an  attempt  to  fix  the  weight  of  authority  as 
between  the  three  forms  advocated. 

Following  the  decision  in  Smyth  v.  Ames  there  was  a 
marked  lull  in  valuation.  When  the  reproduction  theory 
reentered  the  arena  in  1909,  it  came  full  grown,  not  the  un- 
defined infant  suggested  by  Justice  Harlan  in  1898.  The 
theory  had  been  developed  outside  the  Supreme  Court, 
we  may  add,  without  its  sanction. 

Even  prior  to  the  memorable  Ames  Case  the  lower  courts 


VALUATION  METHODS  101 

had  dealt  with  the  theory.  In  1896  Judge  Woolson,  in  the 
case  of  Capital  City  Gaslight  Company  v.  City  of  Des 
Moines,1  in  determining  the  reasonableness  of  gas  rates 
based  his  estimate  upon  the  estimated  cost  of  an  equally 
efficient  plant.  In  1897  the  Supreme  Court  of  Minnesota,  in 
the  case  of  Steenerson  v.  Great  Northern  Railway  Com- 
pany,2 in  considering  the  reasonableness  of  a  rate  reduction 
made  by  the  Minnesota  Railroad  and  Warehouse  Commis- 
sion held  that  as  values  had  declined  reproduction  cost,  not 
original  cost,  must  control. 

The  case  emphasizes  the  true  origin  of  the  theory.  It  was 
founded  in  the  over-zealous  efforts  of  attorneys  for  the 
State.  It  was  forced  upon  the  Court  in  an  effort  to  lower 
value.  So  far  as  the  origin  of  the  theory  is  concerned  the 
utilities  have  been  guiltless.  Their  fault  lies  in  their  miscon- 
struction and  misapplication  of  the  theory. 

In  1902,  in  the  case  of  Kennebec  Water  District  v.  City 
of  Water ville,3  discussing  a  valuation  for  purchase  purposes 
not  rate-making  the  Maine  Supreme  Court  interpreted  re- 
production cost  to  mean  the  replacing  of  the  present  system 
by  one  substantially  like  it,  in  its  present  condition  and 
with  its  present  efficiency.  Six  years  later  the  Federal  Court 
held,  in  Spring  Valley  Water  Company  v.  San  Francisco,4 
that  the  cost  of  a  substitute  system  might  be  considered, 

1  72  Fed.  829. 

*  69  Minn.  353,  72  N.W.  713.  The  Court  said:  "Counsel  for  the  railway 
company  dwell  much  upon  the  original  cost.  .  .  .  No  guaranty  was  ever 
given  by  the  State  to  the  old  road  that  the  price  of  materials  and  the  cost 
of  construction  would  not  decline,  or  that  capital  invested  in  railroads 
would  not  be  subject  to  like  vicissitudes  as  capital  invested  in  other  en- 
terprises. Modern  improvements  and  other  causes  have  continued  to  re- 
duce the  cost  of  construction  of  all  kinds  of  new  plants,  and  to  reduce  the 
value  of  old  plants,  or  render  them  wholly  worthless,  and  the  State  did  not 
guarantee  that  those  causes  should  not  in  like  manner  affect  the  capital  in- 
vested in  railroads.  Then  the  material  question  is  not  what  the  railroad 
cost  originally,  but  what  it  would  now  cost  to  reproduce  it." 

1  97  Me.  185,  54  Atl.  6;  see  also  Brunswick  &  T.  Water  District  v.  Maine 
Water  Co.,  99  Me.  371  (1904). 

4  165  Fed.  667. 


102  FAIR  VALUE 

but  could  not  be  made  the  controlling  element  in  the  valu- 
ation. 

In  1909  John  W.  Alvord  stated  his  theory  in  detail 
before  the  American  Water  Works  Association.  We  feel 
justified  in  quoting  from  it  at  length  because  it  is  largely 
responsible  for  the  utility  concept  of  reproduction  cost.  His 
statements  were  in  part: 

In  estimating  the  cost  of  reproducing  a  plant  it  is  obviously  im- 
portant to  consider  the  reproduction  as  taking  place  in  a  way  that 
is  humanly  possible.  Now  it  is  not  humanly  possible  to  construct 
a  plant  in  the  past,  or  in  one  day,  or  by  the  substitution  of  hind- 
sight for  foresight;  therefore,  if  we  are  to  avoid  flights  of  construc- 
tite  fancy,  we  are  compelled  to  consider  the  reproduction  as  tak- 
ing place  in  the  near  future  in  reasonable  and  workable  periods  of 
time,  and  without  special  foreknowledge  other  than  that  gained 
from  experience  with  similar  construction  and  familiarity  with 
costs  in  the  near  past.  To  do  other  than  this  will  not  be  "repro- 
ducing." 

A  concept ional  starting  plant  which  is  in  process  of  being  esti- 
mated must  be  made  to  pass  through  all  the  preliminary  phases  of 
mental  origination  as  well  as  physical  construction;  it  must  con- 
sider the  time  and  cost  necessary  to  devise,  conceive,  design,  nego- 
tiate, administer,  and  direct,  as  well  as  the  labor  cost  of  digging 
and  building,  and  the  duplication  which  we  try  to  imagine  in- 
volves the  re-creation  of  many  subordinate  structures,  appliances, 
and  much  machinery  which  will  have  been  removed  or  will  have 
ceased  to  exist.  .  .  . 

The  conceptional  starting  plant  must,  of  course,  finally,  pre- 
cisely accord  in  form,  dimension,  and  extent  with  the  existing  or 
going  plant.  .  .  . 

The  .  .  .  plant  should  .  .  .  deal  with  all  difficulties  known  to  be 
originally  encountered  in  constructing  the  existing  or  going  plant, 
notwithstanding  such  difficulties  might  now  be  easily  modified  or 
eliminated  by  a  forewarned  intelligence. 

The  value . . .  should  be  computed  upon  such  prices  of  labor  and 
material  as  it  would  seem  safe  for  a  prudent  man  to  commit  him- 
self to  and  for  such  reasonable  period  in  the  near  future,  as  expe- 
rience shows  will  properly  be  required  for  construction.  .  .  . 

The  method  of  valuing  .  .  .  will  necessarily  include  all  the  ap- 
preciations in  value  which  logically  and  properly  ought  to  be  cred- 
ited to  the  existing  or  going  plant,  by  reason  of  its  age.  .  .  . 

If  appreciations  are  thus  made  necessary  in  the  process  of  du- 


VALUATION  METHODS  103 

plication,  it  is  also  true  that  on  the  completion  of  the  conceptional 
starting  plant,  it  must  be  reduced  in  value  by  the  measure  in  which 
the  existing  or  going  plant  has  depreciated  through  age,  wear  and 
tear,  by  reason  of  new  inventions,  changes  in  demand,  growth  of 
ideas,  and  other  fluctuating  conditions.  The  time  element  here  is 
of  vital  importance. 

Mr.  Alvord  further  explained  his  conception  of  the  re- 
production cost  theory  in  a  paper  entitled,  "Principles  of 
Public-Utility  Valuation,"  read  before  a  meeting  of  the 
American  Society  of  Civil  Engineers,  November  18,  1914, 
thus: 

.  .  .  Having  familiarized  ourselves  with  the  existing  property 
which  is  to  be  valued,  we  must  in  imagination,  as  a  prolonged  con- 
ceptual process,  retrace,  step  by  step,  every  feature  of  the  proce- 
dure that  would  have  to  be  taken  if  that  property  were  completely 
wiped  out,  and  we  were  responsible  for  the  task  of  entirely  re- 
building it  in  a  reasonable  length  of  time  and  in  a  manner  which 
is  humanly  possible.  Should  we  unconsciously  omit  one  impor- 
tant step  necessary  to  that  rebuilding,  we  will  fail  to  reach  the  full 
cost.  Being  in  possession  of  retrospect,  we  are  constantly  subject 
to  the  temptation  to  substitute  an  easy  and  virtuous  hindsight  for 
that  real  lack  of  foresight  which  would  be  our  condition  in  actual 
life  and  under  ordinary  conditions.  If  we  do  full  justice  to  the  pro- 
cedure, we  must  trace  two  lines  of  human  endeavor,  that  is,  the 
mental  labor  as  well  as  the  physical  labor  which  produced  the  re- 
sult before  us.  Mental  endeavor  will  include  the  development  of 
the  project  and  the  preliminary  steps  of  promotion.  This  must  in- 
clude the  necessary  time  and  pains  that  would  naturally  be  taken 
to  see  that  the  project  is  practical,  the  time  and  attention  necessary 
to  negotiate  the  franchise,  investigate  the  methods  of  service,  and 
estimate  the  preliminary  work.  We  must  at  every  step  of  the  way 
outline  to  ourselves  the  necessary  lengths  of  interlapsing  time  to 
do  all  these  things,  as  well  as  the  amount  of  labor  to  design,  con- 
tract for,  and  actually  build  each  structure.  Much  of  our  cost  will 
be  entirely  dependent  on  the  length  of  time  we  assume  for  these 
practical  operations.  It  is  quite  certain  that  the  most  trained 
imagination,  practically  acquainted  with  similar  construction, 
will  not  always  entirely  succeed  in  redeveloping  every  detail  in- 
volving expense  in  such  a  procedure.  .  .  .* 

1  79  Trans.  A.S.C.E.  144.  Quoted  as  the  basis  of  a  valuation  submitted 
by  Mr.  Anderson  in  Lincoln  v.  Lincoln  Water  &  Light  Co.,  I.P.U.C.  No. 
2496. 


104  FAIR  VALUE 

These  explanations  of  Mr.  Alvord's  theory  fairly  rep- 
resent the  reproduction  method  which  the  utilities,  under 
guise  of  compliance  with  Smyth  v.  Ames,  have  persistently 
tried  to  make  the  predominant  element  in  valuation,1  and 
which  they  now  advocate  before  the  Interstate  Commerce 
Commission  under  the  Federal  Valuation  Act.2 

The  reproduction  theory  of  the  utilities  is  one  developed 
from  the  versatile  mind  of  well-paid  utility  advocates.  It 
has  received  consideration,  but  has  not  been  generally  ac- 
cepted by  regulatory  bodies.  How  widely  it  differs  from  the 
simple  statement  of  Smyth  v.  Ames,  that  "  present  as  com- 
pared with  original  cost  of  construction"  must  be  consid- 
ered, is  apparent  at  a  glance.  The  words  of  the  Ames  Case 
contain  no  command  that  the  existing  plant  be  theoretically 
wiped  from  existence,  or  that  the  lessons  learned  in  its  con- 
struction be  forgotten.  No  direction  is  given  that  the  plant 
constructed  in  the  present  be  identical  with  that  in  exist- 
ence other  than  in  the  service  it  renders.  On  the  contrary, 
any  rational  construction  of  the  term  "  present  cost  of  con- 
struction" would  assume  it  to  mean  construction  with  pres- 

1  Morris  Knowles,  "Relation  of  Reproduction  Cost  to  Fair  Value," 
The  Utilities  Magazine,  vol.  I,  no.  3,  p.  17. 

2  The  synopsis  of  their  brief  filed  preparatory  to  oral  argument  before 
the  Commission  on  September  30  and  October  1  and  2,  1915,  states  their 
theory  thus:  "In  determining  the  cost  of  reproduction  new,  reference  shall 
be  had  to  the  conditions  as  they  exist  at  valuation  date,  but  the  historical 
construction  of  the  property  must  be  taken  into  consideration  whenever 
a  rational  engineering  programme  for  reproduction  would  so  warrant  or 
require.  Conditions  existing  on  the  valuation  date  as  to  population,  busi- 
ness capacity,  and  productiveness  and  property  values  in  the  territory 
served  by  the  carrier  are  to  be  taken.  The  same  quantities  and  classes 
of  grading  materials  which  were  originally  obtained  on  the  right  of  way 
will  be  deemed  to  be  obtainable  in  the  same  places,  and  the  present  cost 
of  moving  the  same  will  be  ascertained.  The  cost  of  acquiring  other  nec- 
essary materials  from  the  most  available  sources  on  valuation  date  will 
be  ascertained.  .  .  .  The  property  of  the  carrier  to  be  reproduced  is  to 
be  considered  as  non-existent.  The  general  conditions  outside  of  the  right 
of  way  and  terminal  lands  of  the  carrier  shall  be  considered  to  be  as 
of  date  of  valuations."  The  same  views  are  expressed  in  all  the  later 
briefs. 


VALUATION  METHODS  105 

ent  knowledge  of  facts  and  condition  at  present  prices  and 
in  accord  with  present  standards. 

Recognizing  these  facts  the  representatives  of  the  public 
have  refused  to  accept  the  theory  submitted  by  the  utilities 
and  demanded  that  reproduction  cost  be  figured  on  the 
basis  of  a  substitute  plant  capable  of  rendering  substan- 
tially similar  service.1 

V.  The  Purpose  of  the  Reproduction-Cost  Appraisal 

The  aim  of  the  substitute-plant  theory  is  to  give  to  the 
public  the  advantage  of  savings  from  increased  economy 
under  present  knowledge  and  present  conditions.  Whether 
or  not  the  doctrine  is  justifiable  depends  upon  what  the  ap- 
praiser seeks  to  accomplish.  The  reproduction  theory  must 
find  its  justification  in  the  purposes  of  valuation.  It  must  be 
fair  to  the  public  and  approximate  the  investment  upon 
which  the  utility  is  reasonably  entitled  to  earn  a  return.  It 
must  produce  a  figure  which  will  attract  capital  without 
being  exorbitant.  The  nearer  it  comes  to  the  actual  justifi- 
able capital  investment  the  more  fully  it  will  promote  the 
aims  of  valuation.  If  the  appraiser  seeks  to  determine  such 
a  value  he  must  base  his  calculations  upon  the  existing  not 
a  substitute  plant.  If  he  views  reproduction  cost  as  a  check 
upon  original  cost,  the  substitute-plant  idea  must  be  dis- 
carded for  original  cost  values  of  the  existing  equipment. 
If  the  appraiser  conceives  of  reproduction  cost  as  a  curb 

1  Whitten,  Valuation  of  Public  Service  Corporation,  p.  73,  sec.  75; 
Capital  City  Gaslight  Co.  v.  City  of  Des  Moines,  72  Fed.  829;  Spring 
Valley  Water  Co.  v.  San  Francisco,  165  Fed.  667;  Statement  of  C.  L.  Gorey 
before  the  Pacific  Coast  Gas  Association  at  its  nineteenth  annual  meeting, 
American  Gas  Light  Journal,  Oct.  23,  1911,  p.  260.  See  also  Murry  v.  Pub- 
lic Utilities  Comm.,  150  Pac.  47  P.U.R.  1915-F-436,  wherein  the  Idaho 
Supreme  Court  said:  "This  court  is  of  the  opinion  that  the  rule  of  cost  of 
reproduction  less  depreciation,  adopted  by  the  Commission,  is  the  correct 
general  rule  or  principle  to  be  applied  in  this  class  of  cases.  However,  we 
believe  that  in  ascertaining  values  in  this  way  the  worth  of  a  new  plant  of 
equal  capacity,  efficiency,  and  durability,  with  proper  discount  for  defects 
in  the  old,  and  the  actual  depreciation  for  use,  should  be  the  measure  of 
value,  rather  than  the  cost  of  exact  duplication." 


106  FAIR  VALUE 

upon  the  utility,  allowing  it  to  collect  rates  upon  no  greater 
sum  than  the  public  would  have  to  pay  for  a  substitute 
plant,  the  theory  would  be  acceptable  if  the  premises  were 
sound.  But  such  an  appraisal  idea  is  not  tenable.  It  confuses 
value  of  property  with  value  of  service.  It  seeks  to  make  the 
appraisal  perform  the  function  of  the  final  valuation.  As  a 
basis  for  determining  the  worth  of  the  service  such  a  theory 
would  work  admirably.  It  would  conform  more  closely  to 
the  true  economic  idea  of  price.  But  as  a  property-valua- 
tion theory  it  is  inexpedient.  It  injects  into  the  attempt  to 
determine  cost  of  service  a  wholly  foreign  element,  value  of 
service.  It  works  in  the  same  vicious  circle  that  market 
value  as  a  rate  base  does.  It  would  nullify,  to  a  large  ex- 
tent, the  attempt  to  exclude  speculation  and  put  the  utility 
on  a  conservative  business  basis.  It  would  force  into  the 
business  unreasonable  risks  necessitating  a  larger  rate  of 
return  and  minimizing  the  possibility  of  regulating  for  the 
general  good.  It  would  diminish  the  certainty  and  regu- 
larity of  income  upon  which  the  rate  of  return  is  fixed  and 
thus  limit  rate  reduction.  It  would,  in  brief,  inject  into 
the  artificial  economic  system  created  for  utilities  a  part  of 
the  old  economic  rules  discarded  as  inapplicable  to  such 
undertakings.  It  would  create  a  conglomerate  regulatory 
system  one  part  of  which  was  not  in  accord  with  the  rest. 
A  compromise  theory  of  reproduction  cost  has  been  de- 
veloped with  the  evident  thought  of  forcing  the  reproduc- 
tion theory  to  approximate  more  closely  the  original  or 
actual  cost  basis  upon  which  it  operates  as  a  check.1  This 
doctrine  involves  the  reproduction  of  the  identical  prop- 

1  Report  of  St.  Louis  Public  Service  Commission  on  Electric  Light  and 
Power  Rates,  Feb.  17,  1911;  Argument  of  H.  P.  Gillette  before  American 
Society  of  Civil  Engineers,  73  Transactions,  A.S.C.E.  p.  382;  Lake  Forest 
v.  Lake  Forest  Water  Co.,  I.P.U.C.  Nos.  2343  and  2275,  P.U.R.  1915-D- 
1008;  Monahan  v.  Pacific  Gas  &  Elec.  Co.  (Cal.)  P.U.R.  1916-B-609;  Re 
Portland  R.  Light  &  Power  Co.  (Or.)  P.U.R.  1916-D-976,  where  repro- 
duction cost  was  limited  to  original  investment  and  original  cost  applied 
to  betterments  and  additions. 


VALUATION  METHODS  107 

erty  under  original  conditions,  but  at  present  prices.  As 
the  theory  differs  from  the  present  conception  of  original 
cost  only  in  that  present,  in  place  of  original,  prices  are 
used  in  the  valuation,  it  needs  little  consideration. 

A  fourth  theory  of  reproduction  cost  recently  received 
with  favor  by  many  of  the  commissions  is  based  upon  nor- 
mal conditions  and  prices.  It  averages  unit  prices  over  a 
period  of  years  in  the  immediate  past,  and  assumes  normal 
construction  conditions.1  It  endeavors  to  eliminate  those 
elements  of  cost  appearing  in  the  strict  reproduction  esti- 
mate which,  because  equipment  was  unsuited  or  prices 
were  abnormal,  would  cause  the  reproduction  estimate  to 
reflect  results  either  abnormally  high  or  low.  The  normal 
cost  estimate  is  not  governed  by  rigid  adherence  to  the  in- 
ventory, though  speculation  and  conjecture  are  not  per- 
mitted. Abnormal  construction  methods  which  might  be 
necessary  in  a  strict  reproduction  estimate  on  account  of 
conditions  which  would  not  usually  prevail  are  eliminated 
in  the  normal  cost  estimate.  It  is  based  upon  modern 
equipment  and  present  normal  market,  labor,  and  physical 
conditions.  It  has  the  advantage  of  excluding  unusual 
prices,  but  increases  rather  than  decreases  the  dependency 
upon  the  individual  judgment  of  the  appraiser. 

VI.  Attempt  to  Discredit  Original  Cost 

The  utility  companies  early  recognized  that  original  cost 
did  not  work  to  their  advantage.  It  resembled  publicity  too 
closely.  It  disclosed  too  many  utility  family  skeletons.  The 
attention  of  the  companies,  therefore,  was  turned  to  re- 
production cost.  In  it  they  readily  recognized  an  opportu- 
nity to  turn  defeat  into  victory. 

A  rigid  campaign  was  instituted  to  discredit  original  cost. 
The  most  vulnerable  point  of  attack  was  the  difficulty  of 

1  Piercy  v.  Citizens  G.,  Elec.  &  H.  Co.  (111.)  I.P.U.C.  No.  4896,  March 
18, 1918.  Normal  cost  has  been  accepted  as  an  appraisal  method  and  uni- 
versally used  in  Illinois. 


108  FAIR  VALUE 

determining  such  cost.  Propaganda  pictured  original  cost  as 
wholly  dependent  upon  a  complete  record  of  the  utility's 
growth  with  explicit  entry  of  all  purchases  and  expendi- 
tures. The  value  of  such  reasoning  was  enhanced  by  the 
fact  that  it  lay  within  the  power  of  the  utility  to  multiply 
the  difficulty  without  serious  danger  of  detection.  Many 
records  probably  had  been  lost  or  destroyed.  Some  com- 
panies found  it  advantageous  not  to  keep  past  records.  Un- 
doubtedly records  were  intentionally  done  away  with. 
There  certainly  was  no  vigorous  effort  made  by  many  of  the 
companies  to  produce  their  books. 

The  difficulty  of  applying  the  original-cost  theory  seems 
to  have  been  systematically  increased  under  advice  of  util- 
ity attorneys,  and  has  unquestionably  been  enormously 
overestimated  by  them.1 

When  any  concerted  attempt  has  been  made  to  put 
the  theory  into  operation,  no  greater  difficulty  has  been  en- 
countered than  in  applying  the  reproduction-cost  method.2 
The  cases  in  which  commissions  have  found  themselves 
really  unable  to  determine  original  cost,  as  the  term  is  now 
understood,  have  been,  almost  without  exception,  those  in 
which  an  original  cost  appraisal  would  have  either  produced 
a  final  valuation  much  smaller  than  that  shown  by  the 
reproduction-cost  appraisal,  or  disclosed  facts  which  the 
company  would  seriously  object  to  proving  against  itself. 

Mr.  Halford  Erickson,  formerly  of  the  Wisconsin  Rail- 
road Commission,  contends  3  that  "the  original  cost  of  the 

1  Brief  of  C.  E.  Smith  in  Lincoln  v.  Lincoln  Water  &  Light  Co.,  I.P.U.C. 
No.  2406,  p.  65;  Brief  of  Wilson,  Warren  &  Child  in  Springfield  v.  Spring- 
field G.  &  E.  Co.,  I.P.U.C.  No.  2138,  p.  19;  Argument  of  the  carriers  be- 
fore the  committee  of  the  Senate  considering  the  Federal  Valuation  bill. 
See  Senate  Report  No.  1290  of  the  62d  Congress,  p.  54:  Remarks  of  Presi- 
dent Hadley  before  the  Senate  Committee;  Report  3d  Session  62d  Con- 
gress, p.  236;  Marquis  v.  Polk  County  Tel.  Co.  (Neb.)  P.U.R.  1915-C- 
140;  Remarks  of  C.  A.  Prouty  before  the  Nat'l  Ass'n  of  Ry.  Commis- 
sioners, Nov.  18,  1914. 

2  See  in  re  Central  Pac.  R.R.  Co.  (Cal.)  P.U.R.  1916-B-845. 

3  The  Utilities  Magazine,  vol.  I,  no.  3,  p.  113. 


VALUATION  METHODS  109 

existing  property  can  be  had  with  even  greater  accuracy 
than  the  cost  of  reproduction."  In  Washington,  where  the 
question  was  carefully  considered  by  the  State,  the  original 
cost  of  all  but  five  per  cent  of  the  entire  railway  mileage  in 
the  State  was  obtained.1  And  a  complete  set  of  the  original 
contracts  covering  practically  every  mile  of  railroad  com- 
prising the  Santa  Fe  System  was  admitted  to  be  in  existence 
by  the  late  Mr.  Hurley,  General  Manager  of  that  road.2 

The  campaign  to  discredit  original  cost  failed  because  the 
propaganda  could  not  obscure  the  fact  that  such  valuation 
is  not  dependent  upon  a  complete  record,  but  may  be  esti- 
mated just  as  reproduction  cost  is  calculated,  and  with  as 
great  or  even  greater  accuracy.  Original  cost  can  be  figured 
upon  the  same  inventory  as  reproduction  cost  by  merely 
substituting  prices  of  material  and  labor,  which  were  cur- 
rent at  the  time  the  items  inventoried  were  put  into  the 
plant,  for  the  present  or  normal  price  used  in  the  reproduc- 
tion cost  appraisal.  The  original  prices  may  be  secured  in 
part  from  the  records  of  the  firm  and  in  part  from  the  mar- 
ket quotations  of  the  period. 

To  bolster  up  their  attacks  the  utilities  sought  to  show 
that  by  accepting  reproduction  cost  as  a  check,  the  Court 
was  discrediting  original  cost  and  proclaiming  the  former 
the  principal  basis  of  valuation. 

The  ludicrous  argument  constantly  reappears  in  utility 
briefs  that  the  phrase,  "the  present  as  compared  with  the 
original  cost  of  construction,"  was  adopted  by  the  Court  in 
Smyth  v.  Ames  in  lieu  of  "the  original  cost  of  construction 
compared  with  the  cost  of  reproduction  new,"  the  innuendo 
being  that  though  the  original-cost  appraisal  had  been  re- 
tained for  purposes  of  comparison,  original-cost  valuation 
had  been  rejected  in  favor  of  a  reproduction  theory  of  val- 
uation. 

1  2d  and  3d  Annual  Report,  Washington  R.R.  Commission,  p.  127. 

2  Argument  of  A.  E.  Helm  of  Kansas  Public  Utilities  Comm.  before  the 
Interstate  Commerce  Comm.  Jan.  26,  1916. 


110  FAIR  VALUE 

The  language  of  the  Court  was : 

We  hold  .  .  .  that  the  basis  .  .  .  must  be  the  fair  value  of  the 
property  being  used  by  it  for  the  convenience  of  the  public,  and  in 
order  to  ascertain  that  value,  the  original  cost  of  construction,  the 
amount  expended  in  permanent  improvements,  the  amount  and 
market  value  of  its  bonds  and  stocks,  the  present  as  compared  with 
the  original  cost  of  construction. 

The  terms  used  by  the  Court  here  seem  unusually  clear. 
Fair  value  is  to  be  determined.  It  is  neither  original  cost  nor 
reproduction  cost;  both  must  be  considered.  The  original 
cost  of  construction  to  date  must  be  ascertained,  the  amount 
and  value  of  outstanding  securities  determined,  and  the 
present  cost  of  construction  estimated.  From  all  these  and 
perhaps  many  more  elements  fair  value  is  to  be  fixed. 

The  instruction  thus  given,  though  far  from  being  as  ex- 
plicit as  could  be  desired,  has  been  literally  followed  by 
most  of  the  courts  and  commissions.1  The  final  valuations 
reached  in  a  few  decisions  have  been  based  almost  entirely 
upon  original  cost.2  Other  cases  deviating  in  the  opposite 
direction  have  seemed  to  consider  only  reproduction  cost 
in  reaching  the  final  valuation.3  No  court,  however,  it  is  be- 

1  Western  Advance  Rate  Case  20, 1.C.C.  S07;  In  re  Berlin  El.  Light  Co. 
3  N.H.  P.S.C.  174;  Springfield  v.  Springfield  Gas  &  Elec.  Co.,  I.P.U.C.  No. 
2138;  Lincoln  v.  Lincoln  Water  and  Light  Co.,  I.P.U.C.  No.  2496;  Buffalo 
Gas  Co.  v.  Buffalo,  3  P.S.C.  2d  Dist.  (N.Y.)  553;  Commercial  Club  v.  Citi- 
zens Gas  &  L.  Co.  (Ind.)  P.U.R.  1916-E-l;  Bogart  v.  Wisconsin  Tel.  Co. 
(Wis.)  P.U.R.  1916-C-1020;  Re  Dunham  (Mo.)  P.U.R.  1916-E-544;  etc. 
See  also  Ames  v.  Union  Pacific  Railway  Co.,  64  Fed.  165;  Appleton  v. 
Appleton  Water  Works  Co.,  5  W.R.C.R.  215;  Report  of  St.  Louis  Public 
Service  Commission  on  United  Railway  Company,  1912. 

2  San  Diego  Water  Co.  v.  San  Diego,  118  Cal.  556,  50  Pac.  633;  Re 
Cripple  Creek  Water  Co.  (Cal.)  P.U.R.  1916-C-788;  Public  Service  Comm. 
v.  Pacific  Tel.  &  Telg.  Co.  (Wash.)  P.U.R.  1916-D-947;  Butler  v.  Lewis- 
ton  A.  &  SW.  St.  R.R.  Co.  (Mo.)  P.U.R.  1916-D-25;  etc.  See  also  Re- 
port of  St.  Louis  Public  Service  Comm.  on  Southwestern  Tel.  &  Telg.  Co. 
1913,  Pub.  Serv.  Comm.  of  New  Hampshire,  1912,  p.  302. 

»  Re  San  Jos6  Water  Co.  (Cal.)  P.U.R.  1915-E-706;  Re  Terminal  Taxi- 
cab  Co.  (D.C.)  P.U.R.  1915-B-546;  In  re  Bronx  Gas  &  Elec.  Co.  (N.Y.) 
P.U.R.  1916-A-440;Steenerson ©.Great Northern Ry.  Co., 69  Minn.  353, 
72  N.W.  713;  Shepard  v.  Northern  Pacific  Ry.  Co.,  184  Fed.  765.  (Re- 


VALUATION  METHODS  111 

lieved  has  taken  the  definite  stand  that  an  inventory  based 
on  the  cost  of  reproduction  is  to  be  accepted  as  the  sole 
guide  in  valuation  for  rate-making  purposes. 

The  argument  upon  which  the  contention  for  reproduc- 
tion cost  as  the  sole  basis  of  final  valuation  is  founded,  has 
been  clearly  stated  in  one  or  two  of  the  lower  court  cases. 
Judge  Hough,  in  Consolidated  Gas  Company  #.  Willcox,1 
said: 

It  is  impossible  to  observe  this  continued  use  of  the  present 
tense  in  these  decisions  of  the  highest  court  without  feeling  that 
the  actual  or  reproductive  value  at  the  time  of  inquiry  is  the  first 
and  most  important  figure  to  be  ascertained. 

And  in  Louisville  and  Nashville  R.R.  Co.  v.  Railroad  Com- 
mission,2 it  was  said: 

And  in  every  case,  after  finding  the  original  cost,  when  possible 
to  be  done,  the  question  would  still  have  to  be  solved  as  to  whether 
such  original  cost  is  the  same  as  the  present  value,  which  would  in- 
volve the  determination  of  the  present  value  for  such  comparison 
independent  of  original  cost,  and  in  no  other  or  better  way  than 
on  reproduction  values. 

The  fundamental  thought  is  that  present  value  must 
mean  reproduction  cost.  The  argument  is  unsound.  It  begs 
the  question.  It  assumes  that  reproduction  cost  and  present 
value  coincide,  and  using  that  assumption  (which  is  the 
very  point  to  be  proved)  as  a  major  premise  the  argument 
proceeds  to  the  conclusion  it  assumed  at  the  start.  The  ar- 
gument may  be  stated  thus:  "All  present  value  is  deter- 
mined by  reproduction  cost.  The  Supreme  Court  has  said 
we  must  determine  present  value.  Therefore,  we  must  de- 
termine reproduction  cost." 

A  very  meager  consideration  of  the  Supreme  Court  cases 
demonstrates  that  no  such  general  proposition  as  has  been 
assumed  can  be  gleaned  from  them.  On  the  contrary,  they 

versed  on  this  point  by  the  Federal  Supreme  Court  in  the  Minnesota 
Rate  Cases.) 
1  157  Fed.  854.  *  196  Fed.  800. 


112  FAIR  VALUE 

have  held  distinctly  that  reproduction  cost  and  present 
value  are  not  synonymous  terms. 

The  unmistakable  trend  of  the  decisions  since  1914  has 
been  away  from  accepting  any  theory  of  reproduction  cost 
as  a  sole  or  predominant  element  in  valuation  and  toward 
recognizing  it  as  a  check  upon  and  supplement  to  original 
or  actual  cost.  An  attempt  is  undeniably  being  made  to 
meet  the  utility  suggestion  of  reproduction  cost  as  the  prin- 
cipal or  sole  basis  for  final  valuation,  by  forcing  that  theory 
of  valuation  into  the  background  and  relying  almost  wholly 
upon  actual  investment. 

VII.  Dejects  of  Strained  Reproduction  Cost 

The  chief  objection  to  the  reproduction  theory,  from  the 
public  standpoint,  is  that  a  valuation  based  thereon  inva- 
riably carries  conjectural  charges  for  overhead  expenses  in 
excess  of  those  actually  paid  and  thus  capitalizes  against 
the  public  sums  which  were  never  expended,  from  which 
the  public  has  derived  no  benefit,  and  which  cannot  be  said 
to  add  to  the  value  of  the  plant,  regardless  of  the  theory  of 
appraisal  adopted.1 

The  reproduction  theory  under  the  constantly  rising 
costs  capitalizes  wages  and  cost  of  material  at  prices  far 
above  those  actually  paid,  and  gives  a  return  to  the  stock- 
holder at  the  expense  of  the  public  on  an  imaginary  invest- 
ment which  he  never  made.  It  values  visionary  capital 
which  has  in  no  way  added  to  the  business  or  made  it  better 
fitted  to  serve  the  public. 

The  same  criticism  applies  to  the  inclusion  in  the  re- 
production-cost inventory  of  the  theoretical  cost  of  cutting 

1  Lincoln  v.  Lincoln  W.  &  L.  Co.,  (HI.)  P.U.R.  1917-B-l.  See  also  Spring- 
field v.  Springfield  G.  &  E.  Co.  (111.)  P.U.R.  1916-C-281.  "  It  is  an  amusing, 
although  regrettable,  commentary  on  the  imperfection  of  regulation,  to 
note  that  the  fair  value  rule,  controlled  by  the  cost  of  reproduction  less 
depreciation  method  is  to-day  perpetrating  the  identical  evils  which  its 
creation  was  designed  to  prevent."  Re  Indianapolis  Water  Co.  (Ind.) 
P.U.R.  1919-A-448,  465. 


VALUATION  METHODS  113 

pavements,  which  in  reality  were  laid  long  after  the  con- 
duits were  placed,  and  which  never  have  been  cut,  and  if 
cut  in  the  future  will  be  paid  for  from  sources  other  than  the 
capital  account.  The  capitalization  of  land  values  never 
paid  by  the  investors  and  which  never  will  have  to  be  paid 
is  another  disputed  phase  of  the  reproduction  theory.  It 
produces  a  fictitious  property  interest  not  protected  by  the 
due-process  clause  because  it  does  not  contribute  to  the  use 
taken.  It  is  in  short  but  a  skillfully  disguised  stock-watering 
scheme.  Honestly  made  and  carefully  used,  however,  the 
modified  reproduction-cost  appraisal  is  an  aid  in  determin- 
ing final  value. 

Most  of  these  defects  which  make  the  reproduction-cost 
theory  unavailable  as  a  sole  basis  for  valuation  are  treated 
in  detail  in  later  chapters. 

VIII.  The  Actual-Investment  Theory 

The  realization  of  the  undesirable  results  attending  the 
application  of  the  reproduction-cost  theory  to  rate-making 
valuation  has  done  much  to  encourage  an  attempt  to  de- 
termine the  true  basis  of  valuation.  It  is  difficult  to  un- 
derstand the  influence  the  reproduction  theory  exerted  on 
courts  and  commissions  unless  it  be  attributed  to  the  pro- 
verbial inability  of  lawyers  to  grasp  accounting  theories. 
Rate  valuation  is  but  one  step  in  cost  accounting.  It  cor- 
responds to  the  factory  inventory.  Reasonableness  of  rates 
is  the  issue.  Cost  of  producing  the  service  is  the  basis  for 
deciding  that  issue.  The  principles  involved  in  this  cost- 
finding  differ  in  no  material  aspect  from  those  involved  in 
the  determination  of  costs  in  the  general  industrial  world. 
Investment,  or  original  cost,  has  always  been  the  basis  of  in- 
dustrial cost-finding.1 

1  "  The  thing  that  is  of  importance  for  the  business  is  what  its  equip- 
ment actually  cost,  not  what  such  equipment  would  have  cost  under 
other  conditions.  If  actual  costs  are  recorded,  with  the  date  of  occur- 
rence, the  cost  of  duplication  can  always  be  figured  by  a  comparison 
of  prices  paid  with  current  prices;  so  the  argument  for  keeping  cost  of 


114  FAIR  VALUE 

The  process  is  most  aptly  stated  by  Professor  W.  M. 
Cole  l  thus: 

If  we  wish  to  know  the  justice  of  the  dividends  of  a  corporation, 
what  do  we  need  to  know?  Three  things:  what  the  investors  have 
put  in;  what  risks  they  have  taken;  what  they  have  taken  out. 
Nothing  else  can  be  of  any  importance  in  settling  our  question. 

In  regulation,  valuation  seeks  to  determine  the  first  of  these 
elements,  the  rate  of  return  considers  the  second,  and  from 
these  two  the  proper  third  is  fixed.  The  sole  difference  be- 
tween cost-finding  in  regulation  and  in  the  factory  is  that 
rates  are  based  upon  reasonable  costs  in  one  and  actual 
costs  in  the  other. 

The  "reproduction-cost-new"  theory  of  appraisal  has  no 
place  in  a  cost  system,  when  actual  cost  figures  are  available. 
It  is  of  value  when  original  cost  cannot  be  readily  ascer- 
tained; but  the  value  it  possesses  is  a  reflected  one.  Repro- 
duction cost  itself  is  not  an  element  in  any  cost  of  produc- 
tion figure.  Its  only  possible  use  is  as  a  basis  for  estimating 
actual  cost.  The  rate-making  valuation  must  be  based  upon 
the  actual,  reasonable  cost  or  the  most  accurate  estimate  of 
that  cost.  Realization  of  this  fact  has  forced  the  reproduc- 
tion theory  into  the  background  in  rate  cases. 

The  movement  favoring  actual  investment  was  given 
momentum  by  the  discovery  that  under  the  strained  con- 
structions placed  upon  the  reproduction  theory  by  utility 
representatives  that  theory  was  becoming  a  most  serious 
menace.  Under  the  sanction  of  the  courts,  utilities  were 
seeking  over-capitalized  values  beyond  the  dream  of  the 
most  ardent  promoters. 

One  stronghold  after  another  of  the  utility-made  repro- 
duction theory  was  attacked  and  successfully  carried.  The 

duplication  on  the  books  entirely  disappears  ...  to  register  on  the 
books  a  capitalization  based  on  earning  capacity  is  not  only  to  register 
an  unnecessary  figure  but  to  bury  the  actual  cost  of  the  assets.  .  .  . 
To  summarize,  no  theoretical  accounting  aims  support  any  view  of  capi- 
talization other  than  cost."  Cole,  Accounts;  Their  Construction  and  Inter' 
pretation,  p.  163. 

1  Accounts;  Their  Construction  and  Interpretation,  p.  168. 


VALUATION  METHODS  115 

elimination  of  cost  of  paving  not  actually  cut,  the  adoption 
of  rational  methods  in  the  determination  of  land  values, 
the  consideration  of  piecemeal  construction,  the  use  of 
average  unit  prices,  the  adoption  of  reconstruction  under 
original  conditions,  the  refusal  to  allow  going  value  as  a 
separate  element,  all  mark  stages  in  the  revolt  against  over- 
capitalization by  way  of  reproduction  cost. 

The  attitude  of  the  commissions  and  courts  to-day  is 
stated  in  the  decision  in  Grafton  County  Electric  Light  and 
Power  Company  l  that  a  fair  return  on  the  outlay  actually 
made  by  the  utility  for  the  public  service,  assuming  rea- 

1  28  A.  T.  &  T.  Co.,  Commission  Leaflets,  533.  See  also  Berlin  Electric 
Light  Co.,  3  N.H.  P.S.C.  174,  21  A.T.  &  T.  Co.  Comm.  L.  781.  "The  the- 
ory [reproduction  cost]  at  first  thought  in  all  cases  is  plausible  and  attrac- 
tive, but  in  the  end  oftentimes  utterly  illogical  and  unreliable,  originally 
adopted  as  a  mere  time-saver  by  mere  theorists,  and  sought  to  be  enforced 
as  against  substantial  and  unbending  facts,"  Des  Moines  Gas  Co.  v.  Des 
Moines,  199  Fed.  204,  207.  The  general  instability  of  the  reproduction-new 
theory  was  realized  and  understood  by  prominent  proponents  of  the  Fed- 
eral Valuation  Act.  Senators  Bristow  of  Kansas  and  La  Follette  of  Wis- 
consin, on  February  24, 1913,  participated  in  the  following  colloquy:  "Mr. 
Bristow:  'There  is  one  point  I  wanted  to  bring  out  with  regard  to  that 
feature  of  the  bill  that  requires  the  Commission  to  ascertain  the  cost  of 
production  new.  Such  a  finding,  in  my  opinion,  is  not  of  any  great  value,  so 
far  as  the  rate-making  is  concerned.  It  is  a  vacillating  quantity;  it  does  not 
represent  in  any  sense  the  investment  of  the  company  in  the  construction 
of  the  road.  To  illustrate :  In  the  suit  that  was  pending  the  estimated  cos£ 
of  the  reproduction  of  the  Northern  Pacific  Railroad  was  involved.  I  am 
informed  the  same  engineer  reported  in  1907  and  in  1909  as  to  the  cost  of 
the  reproduction  new,  and  the  value  fixed  in  1909  was  one  hundred  and 
eighty-five  million  dollars  more  than  the  same  engineer  fixed  the  value 
of  reproduction  new  in  1907.' 

"  Mr.  La  Follette  [in  part] : '  Let  me  say  to  the  Senator  on  this  question, 
that  the  Supreme  Court  of  the  United  States  has  listed  that  as  one  of  the 
values  to  be  considered,  and  it  has  not  yet  by  any  express  declaration  elim- 
inated it  as  a  value  to  be  ignored.  So  it  seemed  to  the  committee  that  we 
ought  to  give  it  its  place  here.  I  will,  however,  say  to  the  Senator  that  7  am 
confident  that  the  views  of  all  the  advanced  commissions  of  the  country  that 
are  doing  this  valuation  work  are  that  there  should  be  very  inconsiderable 
weight  given  to  reproduction  new.'  (Congressional  Record,  3801.)"  Quoted 
from  the  decisions  of  Commissioner  Shaw  of  Illinois  in  the  Springfield  and 
Lincoln  cases.  See  also  Indianapolis  Water  Co.  (Ind.)  P.U.R.  1919-A- 
448,  etc. 


116  FAIR  VALUE 

sonable  prudence  in  investment  and  honesty  and  efficiency 
in  operation,  is  all  that  can  be  allowed. 

The  Public-Service  Commission  of  New  Hampshire  l 
early  recognized  that  property  dedicated  to  the  public  use 
should  neither  increase  nor  decrease  on  account  of  a  change 
in  its  reproduction  cost;  but  that  the  utility  should  be  en- 
abled to  earn  a  fair  return  upon  the  amount  it  had  honestly 
invested,  so  long  as  such  return  could  be  secured  from 
reasonable  rates.  The  Wisconsin  Railroad  Commission 
accepted  the  investment  theory  in  Appleton  v.  Appleton 
Water  Works  Company,2  holding  that  the  actual  total  in- 
vestment in  the  enterprise  should  be  made  the  basis  of 
valuation  for  rate-making  whenever  possible,  though  a 
proper  reconstruction  appraisal  might  be  of  value  as  a 
check  upon  or  aid  to  original  cost.  The  St.  Louis  Public 
Service  Commission  in  1913  took  a  similar  stand,  holding 
that  the  original-cost  method  is  the  preferable  one  where 
there  is  no  circumstance  clearly  indicating  that  the  use  of 
the  method  would  bring  about  an  unjust  result.3 

In  the  Middlesex  and  Boston  Rate  Case  4  the  Massachu- 
setts Public  Service  Commission,  in  accepting  the  original- 
cost  theory,  said: 

It  is  entirely  clear  that  in  the  long  rim  the  rate-paying  public  as 
well  as  the  investing  public  will  be  best  served  if  regulation  takes 
as  its  fundamentally  guiding  principle  an  attempt  to  protect  in- 
vestments honestly  and  prudently  made  and  wisely  managed.  Any 
other  theory  involves  essential  injustice,  tends  to  make  the  devel- 
opment of  our  public  utility  companies  a  speculation  and  not  an 
investment,  operates  as  a  premium  upon  various  kinds  of  fraud; 
invites  into  the  public  service  undesirable  manipulators  instead 
of  sound,  level-headed  business  managers;  makes  every  rate  case 
an  almost  interminable  and  labyrinthine  inquiry  into  values  with 
endless  conflicts  between  so-called  experts. 

In  Edwards  v.  Glen  Telephone  Company  5  the  New  York 
Second  District  Commission  reached  the  conclusion  that 

1  Report  of  Nov.  30,  1912,  p.  302.  2  5  W.R.C.R.  215. 

3  Report  on  South  Western  T.  &  T.  Co.,  Oct.  14,  1913. 

4  October  28,  1914.  B  No.  4184,  P.U.R.  1916-B-940. 


VALUATION  METHODS  117 

if  the  books  of  the  utility  had  been  carefully  kept  the  actual 
figures  formed  a  rate  base  more  equitable  to  both  the  public 
and  the  utility  than  any  figures  based  upon  theory;  and 
that  the  company  should  not  be  given  the  benefit  of  a 
highly  inflated  value  upon  its  property  merely  because  such 
a  value  could  be  worked  out  from  an  imaginary  reproduc- 
tion cost  regardless  of  what  money  had  been  actually  in- 
vested in  the  property. 

In  re  Cripple  Creek  Water  Company  l  the  Colorado 
Public  Utilities  Commission  decided  that  while  actual  and 
reproduction  cost  may  well  be  taken  as  checks  upon  each 
other,  where  original  cost  may  be  obtained  accurately  and 
the  investment  was  made  honestly,  wisely,  and  prudently, 
the  important  test  is  the  original  cost  to  date,  and  esti- 
mates of  reproduction  cost  should  receive  slight  considera- 
tion. 

In  re  Dunham,2  the  Missouri  Public  Service  Commis- 
sion took  a  similar  stand,  holding  that  original  cost  to  date, 
determined  by  a  competent  audit  including  the  amount 
expended  in  permanent  improvements,  furnishes  the  most 
satisfactory  evidence  as  to  value  because  it  is  based  on  facts 
capable  of  more  or  less  exact  determination  under  proper 
accounting  methods;  and  that,  when  expenditures  prove  to 
have  been  reasonably  required,  with  good  business  judg- 
ment, and  the  appreciation  or  depreciation  in  value  is  in 
evidence,  the  consideration  of  original  cost  to  date  is  of  pe- 
culiar aid.3 

The  recent  cases  devote  little  space  to  discussion  of 
either  original  or  reproduction  cost,  but  the  clear  tendency 
is  to  modify  the  reproduction  theory  to  make  the  results  at- 

1  P.U.R.  1916-C-788.  See  also  In  re  Portland  Ry.  Light  &  P.  Co.  (Or.) 
P.U.R.  1916-D-976. 

2  P.U.R.  1916-E-544. 

3  A  majority  of  the  State  regulatory  commissions  have  accepted  the 
actual-investment  theory.  See  Bluefield  v.  Bluefield  Waterworks  &  Imp. 
Co.  (W.Va.)  P.U.R.  1917-E-22;  Monroe  Ind.  Tel.  Co.  (Neb.)  P.U.R. 
1917-E-471;  Lincoln  v.  Lincoln  W.  &  L.  Co.  (111.)  P.U.R.  1917-B-l;  etc. 


118  FAIR  VALUE 

tained  by  it  conform  more  closely  to  original  cost.  Greater 
stress  is  placed  upon  original  cost  in  an  attempt  to  learn 
what  the  actual,  justifiable  capital  expenditure  of  the  util- 
ity has  been. 

The  non-committal  language  and  the  reference  to  Smyth 
v.  Ames  in  Pine  Lawn  v.  West  St.  Louis  Water  and  Light 
Company  *  are  typical  of  the  more  recent  decisions.  The 
actual  well-camouflaged  theory  upon  which  they  proceed 
must  be  determined,  if  it  can  be  found  at  all,  by  a  careful 
reading  of  the  full  decision,  often  of  the  full  record,  not 
from  any  segregated  portion  of  the  decision.  The  Commis- 
sion said: 

We  proceed  to  a  consideration  of  all  the  matters  presented  in 
evidence  bearing  upon  value,  particularly  the  "original  cost  of 
construction,  and  the  amount  expended  in  permanent  improve- 
ments "  which  together  are  now  generally  known  as  the  "original 
cost  to  date,"  also  "the  present  as  compared  with  the  original  cost 
of  construction,"  which  latter  is  presented  in  evidence  as  engi- 
neers' estimates  of  the  cost  of  reproducing  the  property  new  and 
in  its  present  condition,  following  the  rule  in  the  well-known  case 
of  Smyth  v.  Ames.2 

Only  one  recent  case,  Re  Indianapolis  Water  Company,3 
seriously  disputes  the  investment  theory,  and  while  the 
language  used  repudiates  the  doctrine,  except  as  one  of 
many  elements  of  value,  the  decision  really  raises  but  one 
point  inconsistent  with  that  theory.  The  charge  against 
original  cost  is  that  it  fails  to  consider  appreciation.  The 
language  relied  upon  by  the  Indiana  Commission  appearing 
to  make  the  most  serious  attack  on  the  original-cost  theory 
is  that  used  by  the  Federal  Supreme  Court  in  San  Diego 
Land  and  Town  Company  v.  Jasper,  where  the  Court  says :  4 

1  P.U.R.  1917-B-679,  Missouri  Public  Service  Commission. 

2  See  also  Re  Kansas  City  Elec.  Light  Co.  (Mo.)  P.U.R.  1917-C-718; 
Portage  v.  Portage  Water  Co.  (Pa.)  P.U.R.  1917-D-17;  Re  Bronx  G.  &E. 
Co.  (N.Y.  1st  Dist.)  P.U.R.  1917-D-777  dictum;  Greensburg  o.  West- 
moreland Water  Co.  (Pa.)  P.U.R.  1917-D-478. 

3  P.U.R.  1917-E-556. 

4  189  U.S.  442,  23  Sup.  Ct.  571,  47  L.  ed.  892. 


VALUATION  METHODS  119 

It  is  no  longer  open  to  dispute  that  under  the  Constitution 
"what  the  company  is  entitled  to  demand,  in  order  that  it  may 
have  just  compensation,  is  a  fair  return  upon  the  reasonable  value 
of  the  property  at  the  time  it  is  being  used  for  the  public."  San 

Diego  Land  &  Town  Co.  v.  National  City,  174  U.S.  739 Thai 

is  decided  and  is  decided  as  against  the  contention  that  you  are  to  take 
the  actual  cost  of  the  plant,  annual  depreciation,  etc.,  and  to  allow 
a  fair  profit  on  that  footing  over  and  above  expenses. 

Thus  far  the  statement,  considered  as  an  independent  ab- 
stract legal  statement,  would  be  fatal  to  the  original-cost 
theory;  but  the  Court  continues: 

. . .  The  only  evidence  in  favor  of  a  higher  value  in  the  pres- 
ent case  is  the  original  cost  of  the  work,  seemingly  inflated  by 
improper  charges  to  that  account  and  by  injudicious  expenditures. 

Thus  it  appears  that  the  Court  is  not  considering  original 
cost  in  the  sense  in  which  it  has  been  since  universally  ac- 
cepted, nor  in  the  form  in  which  the  Indiana  Commission  de- 
fined it,  but  has  in  mind  the  narrower,  early  construction 
of  the  phrase  synonymous  with  book  value,  which  excludes 
betterments  and  includes  injudicious  expenditures.  The  ob- 
jection the  Court  raises  is  the  direct  opposite  of  the  appre- 
ciation theory  of  the  Commission.  Under  the  more  liberal 
construction  the  elements  of  value  suggested  by  the  utility 
would  have  been  excluded  from  the  original-cost  valuation 
and  the  question  passed  upon  by  the  Court  could  not  have 
arisen. 

IX.  The  Supreme  Court  and  Reproduction  Cost 

Both  the  original-cost  and  reproduction-cost  theories  of 
valuation  were  first  given  definite  form  by  the  decision  in 
Smyth  v.  Ames.  The  next  valuation  case  carried  to  the  Su- 
preme Court  was  San  Diego  Land  and  Town  Company  v. 
National  City,1  decided  the  following  year.  In  this  case, 
after  carefully  reviewing  Smyth  v.  Ames,  the  Court  states 
the  basis  of  calculation  suggested  by  the  applicant.  That 

1  174  U.S.  739,  19  Sup.  Ct.  804,  43  L.  ed.  1154. 


120  FAIR  VALUE 

basis  makes  no  reference  to  present  cost  of  construction  or 
to  reproduction  cost.  The  Court  then  proceeds  to  condemn 
appellant's  basis  of  calculation,  not  because  it  makes  no 
reference  to  reproduction  cost,  but  because  by  not  consider- 
ing present  value  it  works  an  injustice  not  to  the  utility  but 
to  the  consumer,  for  the  original  cost  may  well  exceed  the 
present  value.  There  is  opportunity  for  reproduction  cost 
to  be  set  up  as  a  check  upon  investment,  but  the  criticism 
of  the  Court  contains  no  reference  to  present  cost  of  con- 
struction or  to  reproduction  cost.  It  seems  evident  that  the 
Court  did  not  consider  reproduction  cost  an  essential  ele- 
ment of  value  It  is  probable,  in  view  of  the  fact  that  the 
Court  had  its  recent  decision  in  the  Ames  Case  under  con- 
sideration, that  Justice  Brewer  construed  the  language  Jus- 
tice Harlan  had  used  as  directing  a  comparison  of  present 
value  with  original  cost  of  production,  rather  than  a  com- 
parison between  reproduction  and  original  cost,  or  else 
considered  reproduction  cost  as  but  a  possible  not  a  nec- 
essary check  upon  the  original-cost  theory.  The  failure  of 
Justice  Harlan  to  dissent  from  the  decision  may  reasonably 
be  construed  as  indicating  that  no  great  injustice  had  been 
done  to  his  opinion. 

The  next  Federal  Supreme  Court  case  in  which  the  re- 
production theory  could  arise  as  an  issue  was  San  Diego 
Land  and  Town  Company  v.  Jasper,1  decided  in  1902.  In 
this  case  the  Court  rejects  original  cost  in  its  narrow  sense 
as  the  sole  basis  of  value  because  it  does  not  protect  the  pub- 
lic from  "inflated  and  improper  charges"  and  "injudicious 
expenditures."  The  standard  of  value  fixed  by  the  earlier 
San  Diego  Case  was  accepted.  Neither  the  language  of 
Smyth  v.  Ames  nor  the  case  itself  was  referred  to.  Neither 
the  present  cost  of  construction  nor  reproduction  cost  was 
suggested  as  a  supplement  to,  or  check  upon,  original 
cost.  The  aim  was  the  protection  of  the  public,  not  the 
utility. 

1  189  U.S.  439,  23  Sup.  Ct.  571,  L.  ed.  892. 


VALUATION  METHODS  121 

The  next  case  involving  this  theory  before  the  Federal 
Supreme  Court  was  Stanislaus  County  v.  San  Joaquin  and 
King's  River  Canal  and  Irrigation  Company,1  decided  in 
1904.  The  decision  was  based  wholly  upon  the  two  San 
Diego  Cases  cited  above.  Smyth  v.  Ames  was  referred  to 
only  indirectly  as  having  been  followed  in  those  cases. 
Neither  present  construction  nor  reproduction  cost  was 
mentioned. 

Reproduction  cost  came  before  the  Supreme  Court  as  a 
direct  issue  for  the  first  time  in  1909  in  Knoxville  v.  Knox- 
ville  Water  Company.2  In  discussing  its  use  by  the  master 
of  the  lower  court,  Justice  Moody  says: 

The  cost  of  reproduction  is  one  way  of  ascertaining  the  present 
value  of  a  plant  like  that  of  a  water  company,  but  that  tost  would 
lead  to  obviously  incorrect  results  if  the  cost  of  reproduction  is 
not  diminished  by  the  depreciation  which  has  come  from  age  and 
use.  .  .  .  The  cost  of  reproduction  is  not  always  a  fair  measure  of  the 
•present  value  of  a  plant  which  has  been  in  use  for  many  years.  The 
items  composing  the  plant  depreciate  in  value  from  year  to  year 
in  a  varying  degree. 

After  a  lapse  of  eleven  years  the  Court  again  discusses  the 
reproduction  cost  hinted  at  in  the  dictum  of  Smyth  v.  Ames. 
It  does  not  consider  reproduction  cost  a  necessary  element 
of  value.  The  decision  refers  to  no  requirement  in  the  Ames 
Case.  It  merely  says  that  such  an  element  of  value  is  admis- 
sible if  properly  used,  not  as  establishing  a  final  valuation, 
but  as  evidence  of  present  value.  The  prodigal  is  welcomed 
back,  not  with  thanksgiving,  but  dubiously  with  criticism. 
It  is  recognized,  not  as  an  end,  but  as  a  means  toward  an 
end,  and  that  end  is  the  "fair  present  value"  of  the  prop- 
erty. It  is  evident,  therefore,  that  the  results  obtained  by 
the  reproduction  method  were  not  the  fair  present  value, 
but  only  one  element  in  the  indication  of  that  value. 
The  Court  stands  just  where  it  did  in  1898;  the  reproduc- 

1  192  U.S.  201,  62  Sup.  Ct.  241,  48  L.  ed.  406. 

2  212  U.S.  1,  29  Sup.  Ct.  149. 


122  FAIR  VALUE 

tion  cost  is  a  check  upon  actual  investment  to  protect  the 
public  from  "inflated  and  improper  charges"  and  "injudi- 
cious expenditures." 

In  Willcox  v.  Consolidated  Gas  Company1  the  Court  had 
occasion  to  state  the  test  of  rate  reasonableness  again,  the 
same  year.  It  fixed  "  the  fair  present  value"  as  the  criterion. 
No  specific  mention  was  made  of  present  cost  or  reproduc- 
tion cost.  The  decision,  however,  seems  based  upon  the 
latter  theory.  In  considering  present  value,  the  Court  said: 

If  the  property  which  legally  enters  into  the  consideration  of 
the  question  of  rates  has  increased  in  value  since  it  was  acquired, 
the  company  is  entitled  to  the  benefit  of  such  increase.  That  is,  at 
any  rate,  the  general  rule.  We  do  not  say  there  may  not  possibly 
be  an  exception  to  it  where  the  property  may  have  increased  so 
enormously  as  to  render  a  rate  permitting  a  reasonable  return 
upon  such  increased  value  unjust  to  the  public. 

This  case  marks  the  climax  of  reproduction-cost  valu- 
ation. The  fruits  of  unrestrained  flights  of  imagination 
through  the  capital  accounts  here  reach  a  point  which  ren- 
ders a  reaction  inevitable.  The  Court  has  lost  sight  of  both 
the  aim  and  the  basis  of  regulation.  It  is  thinking  only  of 
the  safeguards  of  private  property  and  disregarding  wholly 
the  purpose  of  property  and  the  social  interest  therein. 
The  result  of  the  narrowed  vision  was  that  the  Court  went 
astray  on  the  one  phase  of  the  question  it  did  have  in  mind. 
It  in  effect  gives  private  property  in  the  regulated  business 
greater  protection  than  it  would  have  enjoyed  in  the  absence 
of  regulation  by  guaranteeing  a  return  on  a  non-productive 
element  of  value.  This  is,  to  say  the  least,  straining  the  Con- 
stitution to  the  limit. 

The  holding  even  here,  however,  does  not  attempt  to 
saddle  the  burden  of  increased  prices  of  material  and  in- 
creased wages,  the  cost  of  paving  never  cut,  and  other 
imaginary  values  of  the  strained  reproduction  theory  upon 
the  public  for  the  benefit  of  a  utility  which  never  paid  the 
1  212  U.S.  19,  29  Sup.  Ct.  192,  53  L.  ed.  382. 


VALUATION  METHODS  123 

increased  prices.  The  Supreme  Court  has  never  sanctioned 
the  conjectural  reproduction-cost  theory  for  any  use  in 
valuation.  The  intent  of  the  decision  was  merely  to  allow 
the  utility  in  common  with  all  others  the  benefit  of  increased 
values.  It  is  but  a  restatement  and  explanation  of  the  doc- 
trine of  the  San  Diego  Cases  upon  which  it  is  predicted. 

In  Lincoln  Gas  and  Electric  Light  Company  v.  Lincoln l 
the  reproduction  cost  was  used  by  the  master  "as  one 
means  of  finding  the  present  value."  The  Court  did  not 
refer  to  the  propriety  or  impropriety  of  the  means,  but  re- 
stated the  rule  of  the  San  Diego  Case  and  remanded  the 
case  for  the  lower  court  to  determine  value  more  accurately 
than  had  been  done. 

In  Simpson  v.  Shepard,2  commonly  known  as  the  Second 
Minnesota  Rate  Case,  the  Court  reverts  to  the  rule  of 
Smyth  v.  Ames,  restating  it  without  comment.  That  rule 
stated  substantially  the  system  followed  by  the  master  in 
appraising  the  property,  though  his  final  valuation  was 
based  on  the  reproduction  cost.  In  commenting  upon  this 
finding  the  Court  said: 

It  is  manifest  that  an  attempt  to  estimate  what  would  be  the 
actual  cost  of  acquiring  the  right  of  way  if  the  railroad  were  not 
there  is  to  indulge  in  mere  speculation.  The  railroad  has  long  been 
established;  to  it  have  been  linked  the  activities  of  agriculture, 
industry,  and  trade.  Communities  have  long  been  dependent 
upon  its  service,  and  their  growth  and  development  have  been 
conditioned  upon  the  facilities  it  has  provided.  The  uses  of  prop- 
erty in  the  communities  which  it  serves  are  to  a  large  degree  de- 
termined by  it.  The  values  of  property  along  its  line  largely  de- 
pend upon  its  existence.  It  is  an  integral  part  of  the  communal 
life.  The  assumption  of  its  non-existence,  and  at  the  same  time 
that  the  value  that  rests  upon  it  remains  unchanged,  is  impossible 
and  cannot  be  entertained.  The  conditions  of  ownership  of  the 
property  and  the  amounts  which  would  have  to  be  paid  in  acquir- 
ing the  right  of  way,  supposing  the  railroad  to  be  removed,  are 
wholly  beyond  reach  of  any -process  of  rational  determination. 
The  cost-qf-reproduction  method  is  of  service  in  ascertaining  the 

1  223  U.S.  349.  2  230  U.S.  352,  33  Sup.  Ct.  729. 


124  FAIR  VALUE 

present  value  of  the  plant,  when  it  is  reasonably  applied  and  when 
the  cost  of  reproducing  the  property  may  be  ascertained  with  a  proper 
degree  of  certainty.  But  it  does  not  justify  the  acceptance  of  results 
which  depend  upon  mere  conjecture.  It  is  fundamental  that  the 
judicial  power  to  declare  legislative  action  invalid  upon  constitu- 
tional grounds  is  to  be  exercised  only  in  clear  cases.  The  consti- 
tutional invalidity  must  be  manifest,  and  if  it  rests  upon  disputed 
questions  of  fact,  the  invalidating  facts  must  be  proved.  And  this 
is  as  true  of  asserted  value  as  of  any  other  fact. 

The  Court  clearly  sounds  the  death-knell  of  the  claim  of 
reproduction-cost  advocates  that  that  theory  is  to  be 
adopted  as  the  sole  measure  of  present  value.  It  fixes  the 
true  place  of  the  theory  with  equal  clearness.  Reproduction 
cost  when  rightly  used  is  of  worth  in  determining  fair 
present  value.  It  is  too  speculative  to  be  trusted  alone, 
but  as  a  check  upon  other  estimates  it  is  admissible,  con- 
ditioned always  upon  its  being  fairly  used. 

The  Second  Minnesota  Rate  Case  is  the  most  recent  com- 
ment of  the  Supreme  Court  upon  reproduction  cost.  It 
leaves  little  room  for  further  discussion  by  future  cases. 

X.  Summary 

Fair  value  deals  primarily  with  valuation  for  rate-mak- 
ing purposes.  The  fair  value  discussed  is  the  present  rea- 
sonable investment  represented  by  the  tangible  and  intan- 
gible property  which  the  utility  owns.  It  is  based  upon 
original-cost  and  reproduction-cost  appraisals  showing  the 
total  investment  in  the  property.  The  final  valuation  is 
worked  out  from  the  inventory  figures  and  the  corporate 
history  which  accompanies  them  as  a  sort  of  exhibit  or 
supplement.  The  aim  is  to  determine  the  actual,  unim- 
paired, reasonable  investment  in  property  used  and  useful 
in  rendering  the  public  service.  For  this  purpose  the  origi- 
nal-cost appraisal  serves  best,  when  accurately  drawn.  The 
reproduction-cost  appraisal,  when  it  approximates  facts 
and  avoids  the  flights  of  fancy  which  have  so  often  marred 
it  in  the  past,  is  serviceable  as  a  check  upon  and  supple- 


VALUATION  METHODS  125 

ment  to  the  original-cost  estimate.  The  final  valuation  is  a 
heterogeneous  estimate  based  in  part  upon  original  cost, 
in  part  upon  reproduction  cost,  excluding  all  values  not 
used  or  useful  for  the  public  service,  deducting  depreciation 
from  the  inventory  figures  to  arrive  at  present  value  or  un- 
impaired investment,  and  taking  into  consideration  all  the 
equities  of  the  particular  case.  It  follows  no  definite  for- 
mula, it  acknowledges  no  binding  precedent.  It  is  based 
on  natural  justice  and  equity,  bounded  by  the  constitu- 
tional safeguards  of  property,  the  necessity  of  attracting 
capital,  and  the  dominating  limitation  that  rates  must  not 
be  fixed  above  the  value  of  the  service. 


part  n 

THE  APPLICATION  OF  THE  THEORY  OF  FAIR  VALUE 


CHAPTER  VI 
THE  VALUATION  OF  TANGIBLE  PROPERTY 

I.  Tangible  and  Intangible  Values 

The  property  representing  the  reasonable  unimpaired 
investment  is  of  two  kinds,  tangible  and  intangible.  The 
tangible  property  of  the  utility  includes  its  lands,  buildings, 
equipment,  and  property  interests,  including  water  rights. 
The  intangible  property  is  almost  innumerable,  depending 
in  the  reproduction  inventory  upon  the  versatility  of  the 
appraiser's  mind.  It  includes  organization  costs,  engineer- 
ing, superintendence,  legal  expenses,  contingency  allow- 
ances, etc. 

We  are  here  concerned  with  tangible  property.  Its  valua- 
tion is  less  speculative.  Two  problems  are  encountered:  (1) 
what  property  items  are  to  be  included  in  the  final  valua- 
tion; (2)  to  what  extent  has  the  investment  in  those  items 
been  depreciated  by  ordinary  wear  and  tear  and  by  obso- 
lescence. We  deal  now  with  the  first  of  these  questions. 

II.  Property  not  Used  or  Useful 

Not  all  property  value  of  the  utility  can  be  allowed  for 
rate-making  purposes.  Often  the  company  seeks  to  carry  in 
its  capital  account  large  values  representing  discarded  prop- 
erty. Real  estate  no  longer  required  for  utility  purposes 
held  pending  an  advantageous  sale,  machinery  superseded 
by  more  modern  equipment  before  being  junked,  power 
plants  held  for  emergency  use  in  connection  with  trans- 
mission-line service,  and  similar  items,  some  with  a  sem- 
blance of  present  usefulness,  none  with  a  present  use,  are 
retained  in  the  capital  account.  A  valuable  tract  of  land 
suitable  for  an  office  or  power  site  may  be  used  for  storage 
when  a  much  cheaper  lot  would  serve  the  purpose  equally 


130  FAIR  VALUE 

well.  A  structure  may  be  built  with  capacity  far  in  excess  of 
the  needs  of  the  present  or  immediate  future.  Lands  may  be 
purchased  at  an  opportune  time  to  be  held  fot  distant  use 
as  a  terminal  site,  etc.  The  valuation  rule  in  such  cases 
when  a  rate-making  base  is  sought  is  that  applied  in  all 
cost  estimates  for  price-fixing.  Only  the  property  used  and 
useful  in  rendering  the  service  under  consideration  can  be 
valued.1  The  charge  for  unused  property  must  be  made  to 
profit  and  loss. 

The  valuation  rule  generally  applied  in  such  cases  is 
stated  in  the  La  Crosse  Gas  and  Electric  Company  Case,2 
thus: 

When  such  non-operating  property  is  held  by  a  utility,  the 
only  warrant  for  its  retention  is  expected  savings  and  additional 
net  income.  This  being  the  case,  an  addition  to  the  physical  value 
of  the  plant  for  non-operating  property  can  be  justified  for  rate- 
making  purposes  only  when  the  income  expected  therefrom  is 
added  to  the  actual  income  or  is  deducted  from  the  operating 
expenses. 

And  in  the  case  of  the  Darlington  Electric  Light  and  Water 
Power  Company : 3 

Where  equipment  not  actually  part  of  the  producing  plant  has 
been  retained  and  serves  as  an  emergency  or  reserve  unit,  it  is 
properly  included  as  property  used  and  useful  in  serving  the  pub- 
lic. Equipment,  however,  which  has  been  cast  aside  for  larger 
units,  more  adapted  to  the  present  use  of  the  plant,  or  which  has 
been  abandoned  as  impracticable,  cannot  be  included. 

1  The  State  Commissions  are  unanimous  in  holding  that  abandoned 
equipment  and  property  not  used  or  useful  in  the  utility  business  must  be 
excluded  from  the  valuation  unless  it  is  held  to  meet  the  reasonable  need 
of  the  immediate  future.  The  leeway  allowed  under  this  exception  varies 
somewhat,  being  greater  in  those  States  still  in  the  development  stage  and 
in  one  or  two  jurisdictions  undeniably  pro-utility  in  their  sentiment.  In 
California,  Illinois,  Massachusetts,  New  York,  and  Wisconsin  provision 
for  future  needs  is  limited  as  far  as  possible  without  handicapping  effi- 
cient management.  Property  used  only  for  revenue,  such  as  a  house  rented 
out,  stock  in  trade,  stock  in  other  companies,  etc.,  has  also  been  excluded 
without  exception.  It  seems  useless,  in  the  absence  of  dissent,  to  cite  the 
long  line  of  decisions  from  the  many  jurisdictions. 

2  8  W.R.C.R.  138,  164.  3  5  W.R.C.R.  397. 


VALUATION  OF  TANGIBLE  PROPERTY    131 

In  considering  construction  for  future  needs  the  Federal 
Supreme  Court  excluded  excessive  investment  in  San  Diego 
Land  and  Town  Company  v.  Jasper,1  on  the  theory  that  if 
a  plant  is  built  for  a  larger  area  than  it  finds  itself  able  to 
supply,  or  if  it  has  not  secured  the  customers  contemplated, 
neither  justice  nor  the  Constitution  requires  that  part  of 
the  contemplated  number  should  pay  the  full  return. 

Where  the  investment  was  made  at  the  order  of  the  city 
and  rendered  useless  by  its  action  without  fault  of  the  util- 
ity, the  Wisconsin  Commission  "as  a  matter  of  simple  jus- 
tice" refused  to  exclude  entirely  the  property  from  the  val- 
uation.2 

There  seems  to  be  little  room  to  question  the  equity  of 
refusing  to  force  the  public  to  pay  rates  upon  property 
which  is  neither  used  nor  useful  in  rendering  the  service  it 
receives.  A  valuation  including  such  property  would  force 
rates  above  limits  fixed  by  the  value  of  the  service,  a  limit 
imposed  upon  the  utilities  by  the  Federal  Supreme  Court. 
It  would  violate  all  laws  of  cost  determination  and  disre- 
gard all  principles  of  economics.  The  exclusion  of  such  prop- 
erty from  the  valuation  can  raise  no  question  of  property 
rights  under  the  Fourteenth  Amendment,  for  the  property 
not  being  used  the  use  is  not  taken  and  compensation  can- 
not be  required. 

Where  the  property  is  held  for  emergency  use,  however, 
the  case  is  quite  different.  There  is  an  actual  stand-by,  read- 
iness-to-serve use  rendered  the  consumer  who  pays  the  rate. 
The  service  if  reasonable  in  extent  is  a  legitimate  part  of  the 
regular  utility  business.  Such  property  must  be  included  in 
the  valuation  to  the  full  extent  of  its  worth  for  the  use  to 
which  it  is  put.  The  question  is  complicated.  The  actual  in- 
vestment ceases  to  be  the  determining  element.3  What  part 

1  189  U.S.  439,  446,  23  Sup.  Ct.  571,  47  L.  ed.  892. 

2  Re  Manitowoc  Water  Works  Co.,  7  W.R.C.R.  71,  80. 

3  The  problem  here  presented  illustrates  the  necessity  of  keeping  in 
mind  constantly  the  fact  that  cost  of  service  is  the  element  primarily 
sought.  Value  of  the  property  is  involved  only  in  so  far  as  it  is  a  feature 


132  FAIR  VALUE 

of  this  equipment  is  really  used  as  an  emergency  plant? 
What  is  the  investment  in  property  at  present  used  in  ren- 
dering utility  service?  What  part  of  the  original  investment 
has  been  withdrawn  or  replaced?  The  problem  seems  to  be- 
come, What  would  it  be  reasonable  for  the  utility  under 
existing  conditions  to  invest  in  such  service?  This  line  of 
reasoning,  however,  involves  the  fallacies  of  the  substitute- 
plant  idea,  discarded  as  a  basis  for  determining  cost  of  serv- 
ice because  it  deals  with  value,  not  cost.  The  problem  is 
merely  one  of  apportionment  to  determine  the  part  of  the 
investment  actually  used.  The  utility  is  entitled  to  more 
than  junk  value  because  actual  service  is  rendered;  it  is  not 
entitled  to  actual  investment  because  the  service  for  which 
the  investment  was  made  is  no  longer  rendered.  Invest- 
ment, however,  must  remain  the  measure  of  the  rate-mak- 
ing value  of  such  equipment  so  long  as  the  management  is 
justified  in  retaining  it  in  the  emergency  service  at  all. 

Excessive  investment  to  meet  anticipated  future  de- 
mands presents  still  another  problem.  Adequate  provision 
for  future  requirements  which  must  arise  within  the  imme- 
diate future  are  a  necessary  capital  expenditure.  Any  sound 
management  must  make  comprehensive  preparation  for 
future  needs.  Within  reasonable  limits  such  expenditures 
provide  a  present  service.  But  investment  made  for  future 
needs  where  the  contingency  is  remote  is  but  a  specula- 
tion indulged  in  by  the  utility.  The  cost  of  the  venture  can- 
not be  taxed  against  the  consumer  before  the  property  is 
actually  used.  Excessive  and  unreasonable  investment  in 
property  which  may  sometime  be  useful  in  rendering  the 
service,  so  far  as  present  consumers,  present  rates,  and  pres- 
ent value  are  concerned,  stands  in  no  different  position 
from  any  other  property  not  used  or  useful.  In  the  border- 

of  cost  of  service.  Where  the  property  is  not  used  at  all  or  is  used  in  part 
only  in  rendering  the  service,  the  total  value  of  the  property  cannot  be 
included  in  the  rate-base  valuation.  It  would  not  be  a  proper  charge  to 
cost.  ~~* 


VALUATION  OF  TANGIBLE  PROPERTY    133 

land  between  reasonable  and  unreasonable  investment  for 
future  needs,  between  sound  business  foresight  and  specu- 
lation, the  investor  must  assume  the  entire  responsibility 
for  his  judgment. 

III.  Property  Acquired  without  Cost 

The  fact  that  the  rate-making  valuation  deals  primarily 
with  investment  and  cost,  rather  than  with  value,  raises 
the  question  whether  property  acquired  by  way  of  gift, 
or  otherwise  without  cost  to  the  investor,  may  properly  be 
included  in  the  final  valuation  for  rate-making  purposes. 
The  early  cases,  for  the  most  part,  misled  by  the  term 
"present  value,"  took  the  view  that  because  the  title  to 
the  property  vested  in  the  utility,  its  value  should  be  in- 
cluded for  rate-making  purposes.1  The  reasoning  seems 
fallacious. 

Such  property  represents  no  sacrifice,  investment,  or 
element  in  the  cost  of  service  until  replacement  is  necessary; 
because  the  gift  creates  a  clear  implied  trust  and  the  utility 
holds  but  the  naked  title,  the  beneficiary  interest  being  in 
the  consumers.  If  the  gift  were  not  so  restricted,  if  the  util- 
ity were  not  engaged  in  rendering  a  governmental  service, 
the  donee  would  be  entitled  to  the  benefits  from  the  use  by 
way  of  a  return;  and  to  a  depreciation  allowance  to  keep  his 
investment  intact. 

The  better  view  of  the  question,  and  that  adopted  by 
courts  and  commissions  in  the  more  recent  cases,  is  that 
property  which  does  not  represent  real  investment  or  sac- 
rifice on  the  part  of  the  stockholders  cannot  be  included  in 

1  Findings  as  to  Value  of  Railroads,  R.R.  Comm.  of  Wash.  1907-08,  pp. 
127,  449;  Buell  v.  Chicago,  M.  &  St.  P.  Ry.,  1  W.R.C.R.  324,  356;  Steener- 
son  v.  Gt.  Northern  Ry.,  69  Minn.  353,  72  N.  W.  713;  Tighe  v.  Clinton 
Tel.  Co.,  3  W.R.C.R.  117,  126;  Shepard  v.  N.  Pacific  Ry.,  184  Fed.  765; 
N.Y.N.H.  &  Hartford  R.R.,  Rept.  Mass.  Joint  Comm.  1911,  pp.  51-54; 
Central  of  Georgia  Ry.  v.  R.R.  Comm.  of  Ga.,  U.S.  Dist.  Ct.  Middle 
Dist.  Ala.  No.  261,  Equity;  Central  P.R.R.  (Cal.)  P.U.R.  1916-B-845; 
Bd.  of  Trade  v.  Mountain  Home  Tel.  Co.  (N.Y.  2d  Dist.)  P.U.R.  1916- 
C-688;  etc. 


134  FAIR  VALUE 

the  rate  valuation.1  This  view  certainly  conforms  more 
closely  to  the  purpose  of  valuation  than  the  earlier  rulings 
did.  Thus  service  pipes  and  service  wires  constructed  by  the 
consumer  at  his  expense  cannot  be  included  in  a  valuation 
of  the  company's  property  for  rate-making,  and  right  of 
way  or  other  land  donated  for  utility  use  must  be  excluded.2 

IV.  Property  Acquired  from  Surplus 

The  problem  of  valuation  of  property  created  from  sur- 
plus earnings  is  closely  allied  to  that  of  property  acquired 
without  actual  expenditure  by  the  stockholders.  Where  the 
surplus  put  into  additions  and  betterments  represents  earn- 
ings above  a  fair  return  on  the  investment,  it  would  seem 
that  the  property  thus  acquired  could  differ  little  from  prop- 
erty vesting  in  the  utility  by  way  of  gift  or  private  construc- 

1  San  Diego  Water  Co.  r.  San  Diego,  118  Cal.  556,  50  Pac.  633;  Ash- 
land v.  Ashland  Water  Co.,  4  W.R.C.R.  273;  Ripon  v.  Ripon  Light  & 
Water  Co.,  5  W.R.C.R.  1,  10;  Washburn  c.  Washburn  Water  Works 
Co.,  6  W.R.C.R.  74,  92;  Beloit  v.  Beloit  Water,  Gas  &  Electric  Co.,  7 
W.R.C.R.  187, 215;  Marin  Municipal  Water  Dist.  (Cal.)  P.U.R.  1915-C- 
433;  Pine  Lawn  v.  West  St.  Louis  Water  &  Light  Co.  (Mo.)  P.U.R.  1917- 
B-679;  and  cases  cited  in  Note  3. 

2  "The  real  question  is,  how  many  services  the  company  paid  for  .  .  . 
where  a  service  is  laid  in  the  land  of  the  consumer  and  extended  through 
the  street  to  the  main  in  front  of  his  house  and  paid  for  by  him,  it  becomes 
his  property  and  not  the  property  of  the  company.  If  the  company  is  to  be 
allowed  in  its  capital  account  for  such  a  main,  then  the  consumer  must  con- 
tinue in  perpetuity  to  pay  a  return  of  at  least  6  per  cent  to  the  company 
upon  property  which  he,  the  consumer,  has  paid  for.  It  is  clear  that  this  is 
neither  reasonable  nor  just,  and  cannot  be  permitted."  Buffalo  Gas  Co.  r. 
Buffalo,  3  P.S.C.  (2d  Dist.  N.Y.)  553;  The  holding  has  been  the  same 
where  pole  lines  and  wires  constructed  by  the  consumer  have  become  an 
actual  part  of  the  utility's  property.  See  also  Beloit  v.  Beloit  Water,  G.  & 
E.  Co.,  7  W.R.C.R.  187,  215;  San  Diego  Water  Co.  v.  San  Diego,  118  Cal. 
556, 50  Pac.  633;  San  Diego  Consol.  G.  &  E.  Co.  (Cal.)  P.U.R.  1917-A-930; 
Sandpoint  v.  Sandpoint  Water  &  L.  Co. (Idaho) P.U.R.  1915-F-445;  Apple 
v.  Brazil  (Ind.)  P.U.R.  1915-C-561;  Commercial  Club  v.  Terre  Haute 
Waterworks  (Ind.)  P.U.R.  1916-B-180;  Commercial  Club  v.  Citizens  G. 
&  E.  Co.  (Ind.)P.U.R.  1916-E-l ;  Thayer  v.  Beaver  Valley  Water  Co.  (Pa.) 
P.U.R.  1916-E-962;  San  Gabriel  Valley  Water  Co.  (Cal.)  P.U.R.  1916- 
B-895;  Re  Purchase  Oshkosh  Water  Works  Plant,  12  W.R.C.R.  602; 
Superior  Commercial  Club  v.  Duluth  St.  Ry.  Co.,12  W.R.C.R.  1;  etc. 


VALUATION  OF  TANGIBLE  PROPERTY    135 

tion.  The  two  cases,  however,  are  essentially  different. 
Property  acquired  from  surplus  always  represents  sacrifice 
and  actual  investment  by  the  stockholders.  Donated  prop- 
erty does  not. 

It  is  undeniable  that  profits  in  excess  of  a  fair  return  upon 
the  investment  should  be  distributed  by  way  of  low  rates  or 
impressed  with  a  trust  character  for  the  benefit  of  the  pub- 
lic. But  where  the  public  has  found  it  expedient  to  adopt 
a  laissez-faire  policy  to  encourage  utility  development,  it 
cannot  be  said  that  rates  unduly  high  were  illegally  col- 
lected in  the  absence  of  regulation.  The  title  to  the  surplus 
vested  without  limitation  or  condition  in  the  shareholder  as 
a  reward  for  investing  in  a  venture  which  the  public  itself 
deemed  so  speculative  that  regulation  should  be  waived. 
This  being  true,  the  waiver  of  the  right  to  declare  a  divi- 
dend and  the  creation  of  additions  and  betterments  from 
the  dividend-available  surplus  represents  just  as  great  a 
sacrifice,  just  as  real  an  investment  as  it  would  had  the 
f ormality  of  declaring  a  dividend  and  reinvesting  the  funds 
been  indulged  in. 

In  the  case  of  donation  or  land  grant,  the  aid  has  been 
given  for  a  specific  purpose  and  it  requires  no  great  strain 
upon  the  imagination  to  conceive  of  it  as  the  creation  of  an 
implied  trust  to  use  the  property  donated  for  the  public 
benefit.  The  payment  of  excessive  rates,  however,  differs 
materially.  It  carried  with  it  no  requirement  that  the  funds 
be  left  in  the  business  or  used  for  the  public  benefit.  The  im- 
plied trust  doctrine  could  not  be  applied.  Its  strained  appli- 
cation would  only  penalize  those  who  came  nearest  to  bene- 
fiting the  public. 

Where  the  invested  surplus  arises  from  a  waiver  of  the 
right  to  declare  dividends  from  the  funds  included  in  the 
fair  return  upon  the  investment,  there  can  be  little  ques- 
tion but  that  the  property  acquired  from  it  should  be  val- 
ued for  rate-making. 

There  have  been  few  court  or  commission  rulings  upon 


136  FAIR  VALUE 

the  question  of  invested  surplus  and  such  decisions  as  have 
been  rendered  have  not  been  uniform.1  The  problem  was 
discussed  at  length  by  the  Massachusetts  Commission  in 
Re  Haverhill  Gas  Light  Company.2  The  evidence  showed 
that  the  utility  had  gradually  accumulated  a  large  surplus 
which  it  had  invested  in  the  property.  Its  rates  had  been  as 
low  or  lower  than  those  of  other  companies  of  the  same  class 
in  the  State,  and  the  quality  of  the  service  had  been  the 
best.  The  accumulation  appeared  to  have  been  due  to  ex- 
ceptional management  and  to  a  rapid  gain  in  wealth  and 
population  in  the  community  supplied.  The  Commission 
held  that  since  the  property  in  which  the  surplus  had  been 
invested  must  otherwise  have  been  secured  by  new  capital 
contributed  by  the  shareholders,  it  should  be  used  to  the 
substantial  benefit  of  consumers  and  shareholders  alike.  It 
should  benefit  the  former  by  relieving  them  of  part  of  the 
burden  which  the  investment  of  additional  capital  imposes, 
by  affording  ready  facility  for  minor  extensions,  etc.  It 
should  benefit  the  stockholders  by  strengthening  the  corpo- 
ration, enhancing  the  security  of  the  original  investments, 
and  in  bringing  a  higher  return  than  otherwise.  Such  a  sur- 
plus, the  Commission  admits,  is  by  every  principle  of  law 
the  property  of  the  corporation,  which  has  an  undoubted 
legal  right  to  distribute  it  as  a  dividend  as  it  is  acquired,  or 

1  It  has  been  frequently  held  that  surplus  investment  must  be  valued 
for  rate-making  when  charges  have  not  been  exorbitant  or  when  the  sur- 
plus has  arisen  by  reason  of  failure  to  declare  dividends.  See  Bridgeport 
Natural  Gas  &  Oil  Co.  (W.  Va.)  P.U.R.  1916-C-253;  Re  Valparaiso  Tel. 
Co.  (Neb.)  P.U.R.  1915-E-578;  Re  Salem  Tel.  Co.  (S.  Dak.)  P.U.R. 
1919-B-734.  It  has  been  held  unreservedly  that  all  investments  from  sur- 
plus are  properly  valued;  see  Brymer  v.  Butler  Water  Co.,  179  Pa.  231,  36 
Atl.  249;  Spokane  v.  N.  Pac.  Ry.  Co.,  15  I.C.C.  376,  416;  Fall  River  Gas 
Works  v.  Bd.  of  Gas  &  Elec.  L.  Comm.,  214  Mass.  529,  102  N.E.  475; 
Charlesworth  v.  Omro  Elec.  L.  Co.  (Wis.)  P.U.R.  1915-B-l;  Re  Los  An- 
geles (Cal.)  P.U.R.  1916-F-593.  Another  line  of  cases  holds  as  unquali- 
fiedly that  additions  and  betterments  paid  for  out  of  earnings  form  no 
part  of  the  investment  for  rate-making;  see  Bay  State  Rate  Case  (Mass.) 
P.U.R.  1916-F-221;  Landona.  Lawrence  (Kan.)  P.U.R.  1916-B-331. 

2  Mass.  Bd.  of  Gas  &  Elec.  L.  Comm.,  9th  Ann.  Rept.  p.  90. 


VALUATION  OF  TANGIBLE  PROPERTY    137 

pro  rata  to  the  shareholders  in  case  of  liquidation.  Notwith- 
standing this,  the  Commission  contends,  the  circumstances 
attending  the  accumulation  of  the  surplus  impose  upon  the 
company,  so  long  as  it  continues  to  exercise  the  functions 
of  a  public  monopoly,  the  duty  to  employ  it  for  the  joint 
advantage  of  the  consumers  and  the  corporation. 

The  Commission  erred  in  its  application  of  the  theory  of 
public  interest.  All  public-utility  property  is  affected  with 
a  public  interest.  But  the  encumbrance  thus  created  is  iden- 
tical in  all  cases.  The  origin  of  the  private  title  to  the  prop- 
erty cannot  affect  that  interest.  It  deals  with  the  use,  not 
the  title,  of  the  property.  A  trust  may  be  imposed  upon  the 
property,  or  title  granted  upon  restrictive  conditions,  but 
the  encumbrances  thus  created  are  imposed  in  addition  to 
the  general  public  interest  that  arises  from  the  use  of  the 
property  in  the  public  service.  The  two  types  of  encum- 
brances are  quite  distinct.  Unless  a  specific  limitation  can 
be  shown,  similar  to  those  implied  from  donation  or  acquisi- 
tion of  title  by  way  of  eminent  domain,  invested  surplus 
stands  in  no  different  position  from  other  investment  in 
the  public  service. 

It  has  been  argued  l  that  the  public  has  paid  for  addi- 
tions and  betterments  made  from  earnings.  When  it  is  ad- 
mitted, as  it  must  be,  in  view  of  existing  law,  that  the  excess 
profits  were  the  unrestricted  legal  property  of  the  com- 
pany, and  ceased  to  be  funds  of  the  public,  before  the  deci- 
sion to  divert  them  to  either  dividends  or  additions  and 
betterments  was  made,  it  is  difficult  to  see  how  this  theory 
can  be  sustained.  The  public  has  no  more  paid  for  addition 
made  from  legal  surplus  than  for  betterments  made  from 
capital  earned  as  fair  return  upon  the  reasonable  invest- 
ment declared  as  dividends  and  reinvested  in  the  securities 
of  the  utility. 

Additions  and  betterments  created  from  surplus  earnings 

1  New  Hampshire  Pub.  Serv.  Comm.  Rept.  on  Investigation  of  Rail- 
road Rates,  Nov.  30.  1912. 


138  FAIR  VALUE 

are  investments  and,  if  used  and  useful  in  rendering  the 
public  service,  must  be  included  in  valuation  for  rate-mak- 
ing purposes  if  the  rate  base  is  to  stand  the  test  of  the  due- 
process  clause  of  the  Fourteenth  Amendment. 

This  reasoning  applies,  however,  only  to  additions  and 
betterments.  When  the  expenditures  were  made  for  replace- 
ments the  equipment  cannot  be  capitalized  to  include  the 
new  expenditure.  When  the  surplus  was  made  up  of  funds 
which  should  have  constituted  a  depreciation  reserve,  but 
were  not  so  designated  by  law,  the  remedy  for  failure  to  set 
aside  the  fund  is  by  subtracting  accrued  depreciation  from 
the  original  investment  rather  than  by  disregarding  the  new 
capital  expenditures.  The  results  are  the  same  in  either 
case. 

V.  The  Valuation  of  Land 

The  determination  of  land  value  is  the  most  perplexing 
problem  in  the  valuation  of  tangible  property,  and  one  of 
the  most  troublesome  phases  of  public  utility  regulation. 
Little  assistance  can  be  gleaned  from  the  court  decisions. 
The  Supreme  Court  has  made  few  rulings  upon  land  value, 
outside  decision  in  the  Second  Minnesota  Rate  Case;  and 
practically  all  of  its  decisions  on  this  question  have  been 
rendered  in  connection  with  reproduction-cost  appraisals. 
Since  that  theory  not  only  never  has  received  the  sanction 
of  the  Court  as  a  sole  basis  for  final  value,  but  has  been  de- 
finitely rejected  for  that  purpose,  it  follows  that  the  utter- 
ances of  the  Court,  so  far  as  they  carry  weight  as  precedent, 
must  be  restricted  to  the  limited  area  of  the  reproduction- 
cost  appraisal. 

The  attempts  at  land  valuation  have  been  haphazard. 
Under  the  plea  of  the  magnitude  of  the  task,  multiple  and 
percentage  methods  of  guesswork  valuation  have  been  em- 
ployed, which  can  find  the  slight  excuse  they  own,  only  in 
the  general  chaotic  state  of  valuation  matters.  From  the 
jumbled  experiments  three  fairly  well-organized  methods 


VALUATION  OF  TANGIBLE  PROPERTY    139 

of  land  appraisal  have  been  developed.  They  are  the  local- 
expert  method,  the  sales  method,  and  the  appraiser  method. 
They  apply,  of  course,  only  in  the  reproduction-cost  and 
estimated  original-cost  inventories. 

The  local-expert  method  of  valuing  land  is  but  the  basing 
of  the  appraisal  on  the  opinion  evidence  of  local  real-estate 
experts.  Nothing  could  be  more  uncertain  than  such  opinion 
evidence  as  to  real-estate  values.  The  value  of  the  testimony 
depends  entirely  upon  the  care,  labor,  ability,  training,  and 
honesty  of  the  appraiser. 

The  sales  method  assumes  to  collect  and  compare  sys- 
tematically the  data  relating  to  the  transfers  of  neighboring 
property  having  conditions  or  characteristics  similar  to  the 
land  whose  value  is  to  be  determined.  It  seeks  to  determine 
the  true  market  value  of  the  land.  And  it  attempts  to  do 
this  by  duplicating  as  nearly  as  possible  the  process  em- 
ployed by  the  local  expert.  The  aim  is  to  reach  conclusions 
as  to  value  approximating  those  which  would  be  reached 
by  such  experts  acting  wholly  without  prejudice. 

The  two  methods  base  value  upon  the  same  evidentiary 
facts,  but  the  sales  method  substitutes  the  opinion  of  the 
Commission  for  that  of  the  expert  witness.  The  appraiser 
method  differs  but  slightly  from  the  sales  method.  It  at- 
tempts to  apply  the  judicial  process  of  the  assessor  instead 
of  the  non- judicial  "mental  process"  of  the  local  expert. 

These  methods  have  all  been  criticized  because  they  are 
based  upon  an  estimate.  Business  investments  are  made, 
loans  effected,  taxes  levied,  and  general  credit  based  on 
exactly  similar  estimates  of  land  value.  Any  form  of  land 
valuation  other  than  actual  investment  figures  must  be  an 
estimate  of  the  value  by  some  one  or  other.  The  aim  is 
merely  to  make  that  estimate  as  fair  as  possible  to  all  the 
parties  concerned. 

All  three  of  these  forms  of  valuation  seem  to  be  out  of 
accord  with  the  general  theory  of  rate  valuation.  They  at- 
tempt to  determine  market  value  while  rate  value  is  cost, 


140  FAIR  VALUE 

i.e.,  reasonable  present  investment.  This  fallacy  is,  of 
course,  cured  to  a  large  extent  when  the  market  value 
sought  is  that  at  the  time  of  the  purchase  by  the  utility, 
since  such  market  value  must  approximate  the  actual  in- 
vestment. The  same  reasoning  holds  that  market  value  of 
surrounding,  similar  land  is  the  proper  estimate  of  land 
value  for  the  reproduction-cost  appraisal. 

VI.   The  Original-Cost  Appraisal 

Original  cost,  where  it  can  be  obtained  from  the  books  of 
the  company  or  estimated  with  a  fair  degree  of  accuracy, 
must  be  the  controlling  factor  in  the  final  valuation  of  lands 
for  rate-making.1  It  alone  is  based  upon  the  actual  invest- 
ment which  rate  valuation  seeks  to  ascertain.  When  prop- 
erly determined,  the  original-cost  appraisal  need  only  be 
questioned  concerning  the  fitness  of  the  property  and  its 
actual  use  in  the  service,  to  determine  the  final  land  value 
for  rate-making. 

Two  serious  questions  concerning  land  value  may  arise 
when  the  appraisal  is  based  upon  actual  records.  It  may 
have  happened  that  the  land,  when  acquired,  was  improved 
with  buildings  unsuitable  for  utility  use.  The  first  question 
is,  Shall  the  land  be  valued  for  rate-making  at  the  purchase 
price,  or  at  that  price  plus  the  cost  of  removal  less  the  sal- 
vage value  of  the  buildings?  It  may  have  been  necessary  in 
making  improvements  upon  the  property  as  acquired  to 

1  The  importance  attached  to  this  figure  by  the  State  Commissions  is 
demonstrated  by  the  Report  of  the  Committee  on  Valuation  of  the  Nat'l 
Ass'n  of  Railway  Commissioners,  Nov.  1916,  28th  Annual  Report,  p.  197: 
"Original  cost  is  believed  by  the  members  of  this  Committee  to  be  the 
strongly  controlling  factor  in  the  ultimate  determination  as  to  the  weight 
to  be  accorded  land  values  in  a  rate  case.  .  .  .  There  are  practical  difficul- 
ties in  many  cases  in  determining  the  original  cost  of  the  present  property. 
.  .  .  But  as  the  disputed  principles  in  land  appraisals  involve  sums  aggre- 
gating fully  half  the  outstanding  nominal  capitalization  of  the  entire  rail- 
road system  of  the  Nation,  this  Committee  has  urged  that  no  obstacle  not 
insuperable  be  permitted  to  prevent  the  most  detailed  and  accurate  state- 
ment of  these  important  facts." 


VALUATION  OF  TANGIBLE  PROPERTY    141 

make  outlays  of  a  temporary  nature  or  of  such  character 
that  they  have  ceased  to  be  apparent.  The  second  ques- 
tion is,  What  portion  of  such  expenditures  shall  be  in- 
cluded in  the  final  valuation? 

The  removal  of  unsuitable  buildings  is  a  legitimate  part 
of  the  cost  of  acquiring  the  land,  providing  the  site  was  a 
reasonable  one  under  the  conditions.  But  any  revenue  de- 
rived from  the  sale  of  the  buildings  must  be  credited  to  the 
cost,  and  the  land  be  valued  for  rate-making  at  the  re- 
sulting figure.  It  is  only  thus  that  the  actual  necessary  sac- 
rifice or  investment  can  be  determined. 

All  reasonable  unimpaired  investment  must  be  included 
in  the  valuation.  Expenditures  for  a  temporary  structure 
necessary  to  the  erection  of  a  permanent  bridge  form  a  part 
of  the  cost  of  the  bridge  and  depreciate  with  the  loss  of 
utility  of  the  permanent  structure.  The  cost  of  ballast 
merged  with  the  soil  keeps  a  lessening  worth  so  long  as 
the  ballast  retains  its  identity  and  serves  a  real  purpose 
in  rendering  the  public  service.  Fills,  grading,  and  foun- 
dations, reasonable  in  extent,  constitute  a  proper  element 
of  rate  value  so  long  as  they  are  used  or  useful. 

VII.  Appreciation  of  Land  Values 

The  principal  objection  to  the  original-cost  valuation  of 
land,  advanced  by  the  utilities,  is  that  it  excludes  appre- 
ciated value.  The  issue  thus  raised  is  that  which  underlies 
all  valuation,  i.e.,  is  value  or  cost  sought?  It  has  been  de- 
cided in  general  in  favor  of  cost. 

It  is  difficult,  on  strict  analysis,  to  see  just  how  original- 
cost  valuation  for  rate-making  works  a  hardship  if  regula- 
tion is  justifiable  at  all.  Modern  regulation  first  sets  up  a 
monopolistic  business,  then  imposes  on  it  the  restrictions 
of  competitive  rate-making.  It  may  prove  profitable,  there- 
fore, to  consider  the  action  of  competitive  forces  with  re- 
spect to  appreciation.  Competition  is  subject  to  the  same 
criticism  as  original-cost  valuation.  It  lacks  respect  for  the 


142  FAIR  VALUE 

alleged  divine  right  to  profits  based  on  appreciated  value. 
One  manufacturer  cannot  demand  more  for  his  product 
than  a  near-by  competitor  simply  because  his  factory  site 
has  risen  in  value  more  rapidly,  especially  if  the  rise  in 
value  is  wholly  dependent  upon  the  use  of  the  property  in 
other  lines  of  business.  If  he  wishes  to  take  immediate  ad- 
vantage of  the  increased  value,  he  must  sell  out  and  find  a 
less  valuable  site  for  his  plant.  If  he  continues  to  occupy 
the  more  valuable  site,  competition  will  force  him  to  accept 
a  return  based  upon  his  investment,  not  the  value  of  his 
land.  If  his  business  is  a  public  service  he  has  voluntarily 
waived  the  right  arbitrarily  to  dispose  of  the  property  to 
secure  the  increased  market  values,  presumably  in  consider- 
ation of  the  decreased  risks  of  the  utility  business.  The 
moment  the  "unearned"  increment  grows  to  any  consider- 
able magnitude,  if  regulation  is  justifiable  at  all,  the  prop- 
erty becomes  too  valuable  for  utility  purposes  and  the  ex- 
cess value  will  not  be  used  or  useful  property  within  the 
meaning  of  the  law.  Successful  regulation  can  establish  no 
greater  rate  basis  than  competition  allows. 

One  of  the  chief  aims  of  regulation,  it  will  be  remembered, 
is  the  elimination  of  speculation,  by  placing  of  the  public 
service  upon  a  sound  business  basis  and  limiting  the  return. 
To  base  the  return  upon  appreciated  value  would  reopen 
the  door  to  manipulation  and  speculation,  produce  fluctuat- 
ing rates,  and  bring  back  the  elements  of  every  phase  of 
instability  which  regulation  seeks  to  eliminate. 

The  champion  of  appreciated  rate  value  must  contend 
that  the  increment  is  "new  investment,"  the  use  of  which 
is  taken  by  the  public  within  the  meaning  of  the  due-pro- 
cess clause.  It  is  necessary,  in  order  to  substantiate  this 
claim,  to  show  first  that  the  "new  investment"  is  used  by 
the  public;  that  the  use  is  taken.  Appreciation  is  a  value  in 
futuro  resting  only  upon  the  disposal  of  the  land,  fluctuating 
with  conditions,  and  undeterminable  in  amount  while  con- 
tingent; and  the  owner,  in  consideration  of  franchise  privi- 


VALUATION  OF  TANGIBLE  PROPERTY    143 

leges,  the  use  of  a  portion  of  the  State's  sovereignty,  the 
assurance  of  the  benefits  of  the  economies  possible  under 
monopolistic  organization,  and  the  decreased  risks  under 
government  regulation,  has  covenanted  to  use  the  land  for 
a  certain  purpose  and  refrain  from  arbitrarily  disposing  of 
it  for  his  own  benefit.  Be  it  ever  so  valuable  for  another 
purpose,  therefore,  the  land  has  not  increased  in  value  for 
the  utility  service.  The  consumer  gets  no  better  service. 
No  legal  title  to  increased  value  rests  in  the  owner.  He  can- 
not demand  appreciation  as  a  right.  It  may  or  may  not  come. 
It  is  a  wholly  incidental  increase,  speculative  and  liable  to 
disappear  with  the  next  turn  of  the  wheel.  The  alleged  new 
investment  stands  in  no  different  position  from  other  prop- 
erty neither  used  nor  useful.  To  hold  otherwise  would  be  to 
separate  cost  of  service  and  value  of  service,  and  give  the 
term  "cost"  the  rejected  meaning  of  actual  cost  rather  than 
the  accepted  meaning  of  reasonable  cost.  The  advocate  of 
appreciated  value  for  rate-making  closes  his  eyes  to  the 
value-of-service  limitation  to  which  the  Supreme  Court 
has  more  unswervingly  adhered  than  to  the  cost-of -service 
rule  itself. 

It  may  be  of  assistance  here  to  revert  to  the  considera- 
tion of  the  nature  of  private  property.  It  is  a  bundle  of 
rights  existing  for  the  benefit  of  the  public  and  increasing 
or  decreasing  numerically  as  the  public  directs  by  way  of 
the  police  power.  In  the  case  of  appreciation  the  public 
welfare  requires  that  rates  be  limited  to  cost,  that 
appreciated  land  value  be  left  to  the  owners  to  vest  at  their 
current  value  when  the  land  is  disposed  of,  but  that  so  long 
as  the  land  is  employed  in  the  public  service  those  values 
cannot  be  considered  in  rate-making,  since  they  require 
no  additional  sacrifice  or  outlay  and  they  add  nothing 
to  the  service  rendered.  The  limitation  is  characteristic  of 
all  government  regulation  and  no  more  retroactive  than 
any  other  limitation  upon  private  property  rights  in 
promotion  of  the  common  good.  The  contingent  right  to 


144  FAIR  VALUE 

the  increased  value,  if  it  is  not  wiped  out  before  the  land  is 
sold,  is  not  within  the  protection  of  the  due-process  clause 
because  it  does  not  add  to  the  service,  and  the  service,  not 
the  property,  is  the  thing  taken  and  to  be  paid  for.  Only 
property  values  directly  contributing  to  the  service  taken 
can  be  brought  within  the  limitations  of  the  Fourteenth 
Amendment. 

Justice  Van  Fleet,  in  San  Diego  Water  Company  v. 
San  Diego,1  in  considering  the  general  problem  of  increase 
in  values  held  that  it  would  be  unjust  to  permit  consumers 
to  plead  that  a  similar  works  could  now  be  constructed  at 
a  less  cost,  and  equally  unjust  to  require  them  to  pay  an 
enhanced  price  on  the  ground  that  it  would  now  cost  more 
to  construct  similar  works.  Such  a  contingency  might  hap- 
pen, the  Court  agreed,  but  to  increase  rates  for  that  reason 
would  allow  the  company  to  make  a  profit,  not  as  a  reward 
for  its  expenditures  and  services,  but  by  way  of  a  speculation 
in  which  the  company  or  consumer  wins  or  loses  upon  the 
casting  of  a  die,  or  equally  unpredictable  market  fluctua- 
tions. 

The  same  line  of  reasoning  is  applied  specifically  to  ap- 
preciation in  Re  Bay  State  Street  Railway  Company,2 
where  the  Massachusetts  Public  Service  Commission  held 
that  car  riders  cannot  be  expected  to  pay  higher  fares  be- 
cause land  has  increased  in  value  or  lower  fares  because  it 
has  decreased;  that  if  the  company  sells  its  property,  it  is 
entitled  to  whatever  profit  it  makes,  but  so  long  as  the  land 
is  employed  in  the  street-railway  business  it  is  dedicated  to 
a  public  use  and  held  subject  to  the  conditions  attaching 
to  such  use. 

The  Supreme  Court  has  avoided  the  problem  of  "un- 
earned" increment  as  far  as  possible.  Justice  Harlan  did 
not  touch  upon  it  in  the  Ames  Case,3  or  in  San  Diego  Land 

1  118  Cal.  556,  50  Pac.  633. 

2  P.U.R.  1916-F-221;  10  Rate  Research,  120.  See  also  In  re  Chicago 
North  Shore  Elec.  Ry.  Co.,  P.U.R.  1918-A-388. 

*  169  U.S.  466,  18  Sup.  Ct.  418,  42  L.  ed.  819. 


VALUATION  OF  TANGIBLE  PROPERTY    145 

and  Town  Company  v.  National  City.1  He  concerned  him- 
self primarily  with  avoiding  valuation  based  upon  exces- 
sive original  cost  and  security  issues.  Appreciation  was  not 
•mentioned  in  San  Diego  Land  and  Town  Company  v.  Jas- 
per.2 And  the  Knoxville  Case  3  dealt  primarily  with  depre- 
ciation. The  question  was  touched  upon  directly,  however, 
in  Willcox  v.  Consolidated  Gas  Company,4  where  Justice 
Peckham  said: 

If  the  property,  which  legally  enters  into  the  consideration  of 
the  question  of  rates,  has  increased  in  value  since  it  was  acquired, 
the  company  is  entitled  to  the  benefit  of  such  increase.  This  is,  at 
any  rate,  the  general  rule.  We  do  not  say  there  may  not  possibly 
be  an  exception  to  it,  where  the  property  may  have  increased  so 
enormously  in  value  as  to  render  a  rate  permitting  a  reasonable 
return  upon  such  increased  value  unjust  to  the  public. 

This  outgrowth  of  the  condemnation  analogy  and  re- 
production theory,  prefaced  by  the  general  language  as  to 
fair  present  value,  illustrates  the  confusion  in  valuation 
matters.  The  Court  itself  realizes  that  the  doctrine  cannot 
be  lived  up  to;  that  it  is  a  makeshift  rule.  The  danger  of  bas- 
ing rates  on  excessive  land  values  is  realized  and  stated, 
but  the  Court  is  unwilling  to  break  away  from  the  miscon- 
strued rule  of  Smyth  v.  Ames  and  the  reproduction-cost 
theory.  That  step  was  taken,  however,  in  the  Minnesota 
Rate  Cases.5  There  the  Court,  face  to  face  with  the  injus- 
tice of  applying  the  reproduction-cost  theory  when  it  op- 
erated to  allow  a  present  value  based  on  no  actual  invest- 
ment, though  still  voicing  the  theory,  refused  to  apply  it. 
It  clearly  appears,  therefore,  that  the  Supreme  Court  does 
not  consider  that  a  failure  to  incorporate  "unearned"  in- 
crement in  the  rate-base  valuation  amounts  to  a  taking  of 
private  property  within  the  meaning  of  the  due-process 
clause  of  the  Fourteenth  Amendment. 

1  174  U.S.  739,  19  Sup.  Ct.  804,  43  L.  ed.  1154. 

2  189  U.S.  439,  23  Sup.  Ct.  571,  47  L.  ed.  892. 
8  212  U.S.  1,  29  Sup.  Ct.  149. 

4  212  U.S.  19,  52,  29  Sup.  Ct.  192,  53  L.  ed.  382.   6  230  U.S.  352. 


146  FAIR  VALUE 

It  is  proper,  however,  to  consider  appreciation  to  some 
extent  in  the  reproduction-cost  appraisal,  for  each  appraisal 
must  be  consistently  made  in  so  far  as  it  is  possible  to  do 
so  without  violating  reason.  The  reproduction  cost  of  land 
is  the  market  value  of  surrounding  land  of  like  nature,  and 
that  market  value  in  so  far  as  it  exceeds  the  value  at  the 
date  of  original  purchase  by  the  utility  includes  apprecia- 
tion. 

The  State  Commissions  in  the  earlier  cases,  under  the 
influence  of  the  reproduction-cost  theory,  often  allowed 
appreciated  value  l  in  the  final  valuation,  but  the  tend- 
ency since  the  repudiation  of  reproduction  cost  as  the 
principal  basis  of  rate  valuation  has  been  to  exclude  ap- 
preciation.2 

VIII.  The  Reproduction-Cost  Appraisal 

The  preceding  consideration  of  appreciation  indicates 
that  since  the  reproduction-cost  appraisal  still  has  a  place 
in  valuation,  it  is  necessary  specifically  to  consider  its  ap- 
plication to  tangible  property.  In  doing  so,  however,  the 

1  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4.  W.R.C.R.  501; 
Municipal  League  v.  Pacific  G.  &  E.  Co.,  21  A.  T.  &  T.  Co.  Commission 
Leaflets,  699;  Fuhrmann  v.  Cataract  P.  &  C.  Co.,  3  P.S.C.  2d  Dist.(  N.Y.) 
656;  Re  Indianapolis  Water  Co.  (Ind.)  P.U.R.  1917-E-556;  see  also 
Louisville  &  Nashville  R.  Co.  v.  R.R.  Comm.  of  Ala.,  196  Fed.  800,  821; 
Rept.  of  Committee  on  Taxes  &  Valuation,  22d  Ann.  Rept.  of  Nat'l 
Ass'n  of  Ry.  Commrs.,  1910,  p.  141;  21st  Ann.  Rept.  So.  Dakota  R.R. 
Comm.  1910,  p.  27;  Rept.  St.  Louis  Pub.  Service  Comm.  on  Electric 
Rates,  1911,  p.  33;  etc. 

2  Western  Rate  Advance  Case,  20  I.C.C.  307,  337;  North  Coast  Water 
Co.  (Cal.)  26  Comm.  Leaflets,  1161;  see  also  Rept.  Comm.  on  Valuation, 
28th  Ann.  Rept.  Nat'l  Ass'n  of  Ry.  Commrs.,  1916,  p.  197. 

Various  schemes  to  avoid  rejecting  appreciation  and  yet  not  include 
it  in  the  valuation  have  been  developed.  Thus,  in  Steenerson  v.  Great 
Northern  Ry.  Co.,  69  Minn.  353,  72  N.W.  713,  the  return  allowed  on 
land  values  was  reduced  below  that  on  other  elements  of  value;  in 
Queens  Borough  Gas  &  Elec.  Co.,  2  P.S.C.  1st  Dist.  (N.Y.)  544,  appre- 
ciation was  treated  as  income;  and  in  Berlin  Elec.  Light  Co.,  3  N.H. 
P.S.C.  174,  it  was  used  to  offset  development  expenses.  See  also  Bemis 
Rept.  to  Comm.  on  Gas,  Oil  &  Elec.  Light  on  Chicago  Tel.  Co.,  1912. 


VALUATION  OF  TANGIBLE  PROPERTY     147 

limited  scope  and  greatly  modified  form  of  the  reproduc- 
tion-cost inventory  must  be  constantly  kept  in  mind.1 

Reproduction  cost  is  not  an  end  in  itself  in  the  rate-mak- 
ing valuation.  It  cannot  be  made  the  sole  basis  of  final  val- 
uation for  that  purpose.  It  is  supplemental  to  the  original 
cost-to-date  appraisal  and  serves  as  a  check  upon  that 
theory  to  determine  the  actual,  justifiable,  unimpaired  in- 
vestment. 

The  severe  criticism  of  reproduction  cost  is  largely  di- 
rected toward  the  misuse  and  misconstruction  of  the  the- 
ory. It  has  suffered  greatly  in  the  hands  of  supposedly  rep- 
utable and  qualified  utility  engineers  and  attorneys.  No 
flight  of  the  imagination  has  seemed  too  absurd  to  offer  to 
the  public,  provided  only  that  its  acceptance  would  in- 
crease the  rate  valuation.  Gigantic  stock-watering  schemes 
have  been  concocted  under  the  guise  of  allowance  for  con- 
tingencies, the  use  of  multiples,  and  unwarranted  provi- 
sion for  intangible  values. 

Engineers  have  found  it  convenient  and  therefore  nec- 
essary to  increase  the  sums  they  could  reasonably  estimate 
on  the  basis  of  tangible  property  by  adding  a  liberal  allow- 
ance for  contingencies2  to  include  "all  those  items  which 
it  was  impossible  to  see  in  making  an  approximate  estimate 
of  work  already  done"  and  "any  items  that  may  be  over- 
looked."3 In  the  Minnesota  Rate  Cases  this  padding  was 

1  Considerable  stress  has  been  placed  on  the  incorporation  of  the  re- 
production-cost figures  in  the  elements  of  value  enumerated  in  the  Federal 
Railway  Valuation  Act.  The  Act  states  no  specific  purpose  and  requires 
no  final  valuation.  The  reproduction-cost  inventory,  therefore,  has  a 
clear  title  to  consideration.  It  is  in  rate-making  valuation  alone  that  the 
reproduction-cost  sphere  is  greatly  limited  and  the  Federal  Act  does  not 
confine  itself  to  the  determination  of  rate  value. 

2  In  considering  contingencies  at  this  point  we  are  guilty  of  confusing 
tangible  and  intangible  property,  but  consideration  of  the  reproduction 
cost  of  tangible  property  cannot  well  be  separated  from  consideration  of 
parts  of  the  closely  related  intangible  values. 

3  Testimony  of  Engineer  W.  L.  Darling,  Minnesota  Rate  Cases,  Record 
(N.P.),  p.  549.  See  also  the  evidence  of  J.  B.  Berry,  pp.  739,  743;  D.  C. 
Morgan,  p.  2043;  J.  F.  Stevens  (G.N.),  p.  445;  etc. 


148  FAIR  VALUE 

fixed  at  ten  per  cent,  though  the  appraisers  for  the  road 
unanimously  proclaimed  the  allowance  unjustifiably  low.1 
In  Michigan  the  same  percentage,  working  against  the 
roads  because  the  valuation  was  for  tax  purposes,  was 
equally  unanimously  proclaimed  unjustifiably  high.2 

The  engineer  for  the  Commission  in  the  Minnesota  Rate 
Cases  suggested  five  and  a  half  per  cent  as  a  fair  allowance 
for  contingencies.3  Mr.  Jurgensen,  as  chief  engineer  of  the 
Minnesota  Commission,  allows  five  per  cent.4  In  Wiscon- 
sin and  South  Dakota  five  and  one  half  per  cent  has  been 
allowed  and  in  Nebraska  four  per  cent.5  Mr.  A.  I.  Thomp- 
son, of  the  Federal  Valuation  Commission,  fixes  the  proper 
contingency  allowance  at  from  one  half  of  one  per  cent 
to  two  per  cent,4  and  the  Washington  Commission  makes 
no  allowance  for  contingencies.7 

So  far  as  the  final  valuation  is  concerned,  the  contin- 
gency allowance  must  be  wholly  disregarded.  It  represents 
no  actual  investment.  It  is  clear  conjecture,  even  as  to  re- 
production cost.  And  it  merely  emphasizes  the  error  of  in- 
cluding appreciation  and  the  value  of  donated  lands.  The 
unavoidable  result  of  the  use  of  such  an  allowance  is  a 
wider  separation  between  fact  and  theory  and  greater  diffi- 
culty in  establishing  successful  regulation. 

Mr.  R.  J.  McFall  has  pointed  out  that  the  difference  in 
valuation  methods  in  this  one  item  alone  on  the  estimated 
$15,000,000,000  worth  of  railway  property  in  the  United 
States  would  amount  to  the  difference  between  $150,000,000 
and  $1,500,000,000.7  He  might,  in  view  of  the  Washington 
Commission's  stand,  have  eliminated  his  minimum  figure 
entirely.  The  contingency  allowance,  in  other  words,  seeks 

1  See  Record  (N.P.),  pp.  739-43;  1242-45;  and  (G.N.)  p.  445. 

2  See  also  24th  Ann.  Rept.  Nat'l  Ass'n  Ry.  Commrs.,  p.  35. 
*  Testimony  of  D.  C.  Morgan,  Record  (N.P.),  p.  1852. 

4  24th  Ann.  Rept.  Nat'l  Ass'n  of  Ry.  Commrs.,  p.  35. 

6  Senate  Report  of  Valuation,  No.  1290,  62d  Cong.,  3d  Sess.,  p.  172. 

6  2d  and  3d  Ann.  Rept.  R.R.  Comm.  of  Washington,  p.  43. 

7  Railway  Monopoly  and  Rate  Regulation,  p.  80. 


VALUATION  OF  TANGIBLE  PROPERTY    149 

to  credit  the  railways  with  $1,500,000,000  in  addition  to 
all  the  value  that  their  engineers  have  been  able  to  find. 

Not  satisfied  with  this  slight  increase  in  value,  the  engi- 
neers conceived  the  idea  of  increasing  gains  by  applying 
multiples  to  all  or  part  of  the  value  they  were  able  and  un- 
able to  discover.1  The  justification  of  multiples  has  been 
attempted  on  the  theory  that  if  the  property  were  imagined 
out  of  existence  and  buildings  of  from  two  to  twenty  stories, 
according  to  the  ambition  of  the  appraiser,  were  imagined 
on  the  land,  these  visionary  buildings  would  have  to  be  de- 
stroyed to  allow  the  reconstruction  of  the  property;  and  on 
the  theory  that  if  the  land  had  to  be  condemned  again  these 
day-dream  owners  of  sky  castles  would  hold  out  for  unrea- 
sonable figures  and  the  cost  of  condemnation  would  mount 
in  algebraic  progression. 

There  has  been  no  uniform  multiple  worked  out.  There 
has  been  no  agreement  as  to  the  amount  of  the  allowance, 
the  conditions  under  which  it  is  to  be  made,  or  the  values 
to  which  it  is  to  be  applied.  The  courts  have  not  even  agreed 
that  the  multiple  should  be  used. 

The  principle  is  clearly  fallacious.  It  values  property  in 
exactly  the  same  manner  that  a  condemnation  proceeding 
does  and  then  contends  that  because  part  of  the  land  may 
have  to  be  condemned,  a  higher  rate  must  be  allowed  for 
all  of  it.  It  fixes  a  rate  base  higher  than  is  necessary  to  at- 
tract capital  into  the  utility  field.  If  such  a  valuation  were 
indulged  in,  the  "worth  of  the  service"  limitation  would 
force  the  rate  schedule  to  disregard  it. 

1  In  Wisconsin  "a  multiple  of  one  and  one  half  has  usually  been  ap- 
plied to  the  market  value  of  railroad  land  in  cities,  and  in  rural  districts 
a  multiple  of  two  and  one  half  or  three  has  been  used  for  this  purpose.  .  .  . 
It  is  said  that  in  Kansas  and  South  Dakota  at  the  present  time  the  mul- 
tiple ranges  from  two  to  five,  the  average  being  about  three  outside  the 
towns."  McFall,  Railway  Monopoly  and  Rate  Regulation,  p.  108.  See  also 
Rept.  Wis.  Tax  Coram.  1907,  p.  274;  Rept.  Minn.  R.R.  &  Warehouse 
Comm.  1908,  supplement,  p.  17.  In  Texas  25  to  50  per  cent  was  added, 
in  Wisconsin  10  to  150  per  cent,  in  Washington  0  to  500  per  cent,  and  in 
Nebraska  50  to  225  per  cent  for  increased  cost  of  land  for  railway  use. 


150  FAIR  VALUE 

Justice  Hughes,  in  considering  the  use  of  multiples  in  the 
Second  Minnesota  Rate  Cases,  said: 

Assuming  that  the  company  is  entitled  to  a  reasonable  share 
in  the  general  prosperity  of  the  communities  which  it  serves,  and 
thus  to  attribute  to  its  property  an  increase  in  value,  still  the  in- 
crease so  allowed,  apart  from  any  improvements  it  may  make, 
cannot  properly  extend  beyond  the  fair  average  of  the  normal 
value  of  the  land  in  the  vicinity  having  similar  character.  Other- 
wise we  enter  the  realm  of  mere  conjecture . . .  the  allowances  made 
below  for  a  conjectural  cost  of  acquisition  and  consequential  dam- 
ages must  be  disapproved.1 

Commissioner  Shaw,  of  Illinois,  reviews  the  question  of 
land  values  in  the  light  of  the  Minnesota  Rate  Cases  and 
states  what,  it  is  believed,  fairly  represents  the  stand  of  a 
majority  of  the  State  Commissions  of  to-day  thus: 

Land  owned  and  used  for  railroad  purposes  is  of  a  distinctive 
character.  Not  a  lineal  foot  of  the  roadway  may  be  sold  without 
impairment  of  its  functions  as  a  common  carrier. . .  .  There  is  no 
difference  between  a  railroad  and  a  street  upon  which  one  may 
travel  without  charge  other  than  the  tolls  collected  as  taxes  for 
the  improvements  made  upon  the  street,  or  perchance,  for  the 
bonds  with  which  was  purchased  the  land  thus  dedicated  to  the 
public  use.  But  never  is  it  considered  that  a  citizen  shall  pay  more 
to  travel  upon  a  street  merely  because  the  lots  fronting  thereon 
may  have  become  of  great  value.  The  very  idea  is  ridiculous, 
but  it  is  exactly  what  the  carriers  seek  when  they  ask  a  return 
upon  increased  land  values.  The  mere  fact  that  railroads  are 
privately  operated  affects  the  matter  not  at  all  except  to  befog 
the  issue. .  .  . 

A  railroad  has  nothing  to  sell  but  transportation  and  to  such 
sales  must  it  look  for  its  profits.  Land  enhances  in  value  only  be- 
cause its  use  may  become  more  intensive.  A  railroad  shares  in  the 
general  prosperity  of  a  community  because,  as  the  population  in- 
creases, the  normal  use  of  the  carrier's  facilities  becomes  greater 
and  its  opportunity  to  earn  more  upon  the  original  investment  is 

1  230  U.S.  352,  33  Sup.  Ct.  729.  The  use  of  multiples  was  rejected  for 
tax  valuation  in  New  York,  Ontario  &  Western  Ry.  Co.  v.  Shaw,  143 
N.Y.  App.  Div.  811,  128  N.Y.  Suppl.  177;  and  in  the  Rept.  on  Revalua- 
tion of  Railroads  &  Canals,  N.J.,  1911;  see  also  Chicago  &  Northwestern 
Ry.  Co.  v.  Smith,  210  Fed.  632. 


VALUATION  OF  TANGIBLE  PROPERTY    151 

correspondingly  larger.  This  must  be  considered  the  carrier's  pre- 
rogative, rather  than  the  opportunity  to  include  large  amounts  for 
land  values  which  the  railroad'can  never  hope  to  obtain.1 

The  use  of  multiples  to  determine  land  values  is  expressly 
rejected. 

Both  the  multiple  and  contingency  allowance  have  been 
excluded  from  the  reproduction-cost  appraisal  by  the 
weight  of  opinion  in  the  cases  decided  subsequent  to  the 
Second  Minnesota  Rate  Cases. 

What,  then,  it  may  be  asked,  is  the  reproduction-cost 
appraisal  of  land  values  to  be  based  upon.  The  Supreme 
Court  has  said  market  value.  It  has  made  this  ruling  in 
spite  of  the  general  belief  that  rate  valuation  must  be  based 
primarily  upon  unimpaired,  reasonable  investment,  and 
the  Court  rules  correctly.  Reproduction  cost  does  not  and 
cannot  determine  investment,  therefore  it  cannot  serve  as 
a  rate  base.  It  seeks  to  determine  the  investment  that  would 
have  to  be  made  if  the  rate  base  investment  had  not  been 
made.  That  figure  for  land  is  the  market  value.  The  market 
value  includes  appreciation,  it  includes  donated  land,  and 
it  includes  reinvested  surplus.  All  these  elements  admissi- 
ble or  inadmissible  for  the  final  valuation  are  legitimately 
included  in  the  reproduction-cost  appraisal.  That  is  why 
the  claim  for  a  final  valuation  on  the  reproduction-cost 
basis  was  doomed  to  failure  from  the  start.  Reproduction 
cost  cannot  serve  to  show  a  final  rate  value,  but  it  does 
supplement  the  original-cost  appraisal,  serve  as  a  check 
upon  it,  and  aid  greatly  in  the  estimate  of  value  of  the 
service. 

IX.  Valuation  of  Buildings 

Much  the  same  problems  that  arise  in  connection  with 
the  valuation  of  land  are  met  with  in  the  appraisal  of  build- 
ings. Conjectural  allowances  by  means  of  "average  struc- 

1  Chicago,  Milwaukee  &  North  Shore  Electric  Ry.  Co.  (111.)  P.U.R. 
1918-A-388. 


152  FAIR  VALUE 

tures,"1  etc.,  have  been  used  as  short  cuts,  and  the  contin- 
gency allowance  has  been  freely  granted.  Such  practices 
are  less  reprehensible  here  only  because  the  amounts  in- 
volved are  smaller. 

The  actual  investment  in  building  may  be  determined 
with  comparative  ease  when  the  date  of  construction  is 
known.  Prices  of  material  and  labor  as  of  the  date  in  issue 
are  readily  ascertainable,  so  the  appraisal  is  reduced  to  a 
mere  mathematical  problem.  Where  there  is  no  evidence  of 
the  date  of  construction  the  value  of  buildings  has  been 
fixed  by  averaging  the  cost  of  reproduction  new  and  the 
actual-cost  estimate.2 

Difficulty  is  encountered  in  applying  this  method  of 
appraisal,  however,  where  existing  buildings  have  been 
adapted  to  a  use  other  than  that  for  which  they  were  con- 
structed. In  such  cases  the  worth  of  the  service  rendered  by 
the  building  is  clearly  not  equivalent  to  the  investment 
therein.  The  building  has  depreciated  in  value  for  rate- 
making  purposes  in  addition  to  its  physical  depreciation. 
The  investment  has  been  seriously  impaired.  The  worth  of 
the  service,  being  out  of  harmony  with  the  cost  of  service 
if  the  theory  of  impaired  investment  is  rejected,  predom- 
inates. Valuation  in  such  case  seeks  to  determine  the  worth 
of  the  service  rendered,  on  the  theory  that  it  is  equivalent 
to  a  fair  return  upon  the  unimpaired  reasonable  invest- 
ment; and  that  should  the  former  figure  prove  the  smaller 
it  would  necessarily  predominate. 

Where  a  building  is  used  only  in  part  for  the  utility 
service  or,  in  case  of  dual  service,  for  that  service  in  ques- 
tion, only  that  portion  of  the  value  used  and  useful  in  ren- 
dering the  particular  service  can  be  included  in  the  rate  val- 
uation. Structures  erected  far  in  excess  of  present  needs  can 
be  valued  only  to  the  extent  of  the  present  use;  but  ade- 

1  Second  Minnesota  Rate  Cases,  Record  (N.P.),  p.  41,  3207-47.  Morse, 
"Valuation  by  Approximation,"  Utilities  Magazine,  Jan.  1914,  p.  183. 

2  Taylor  v.  Northwest  Light  &  Water  Co.  (Idaho),  P.U.R.  1916-A-372. 


VALUATION  OF  TANGIBLE  PROPERTY    153 

quate  provision  may  properly  be  made  for  growth  in  the  im- 
mediate future.  Buildings  owned  but  not  used  must  be 
wholly  excluded.  And  all  structures  must  be  depreciated  to 
their  present  value. 

X.  Water  Rights 

Consideration  of  water  rights  seems  properly  treated  in 
connection  with  the  valuation  of  tangible  property.  They 
are  of  two  types,  those  rights  arising  from  the  ownership 
of,  or  easement  in,  the  land,  and  those  based  on  contract. 
Consideration  of  the  latter  should  present  few  difficulties. 

A  valuation  for  rate-making  purposes  seeks  to  determine 
the  reasonable,  unimpaired  investment.  A  water-right  con- 
tract which  does  not  create  an  easement,  but  simply  pro- 
vides for  the  purchase  and  sale  of  water  at  a  fixed  rate, 
represents  no  investment.1  The  money  paid  under  such  a 
contract  is  assumed  to  represent  the  fair  value  of  the  serv- 
ice or  commodity  secured.  It  is  an  operating  expense,  not 
a  capital  charge.  If  it  is  assumed  that  payment  is  made  in 
addition  to,  or  in  excess  of,  the  reasonable  value  of  the 
service,  the  added  expenditure  represents  an  unjustifiable 
investment  not  used  or  useful.  Such  an  investment  can- 
not form  a  part  of  the  rate  base.  The  savings  effected  by 
the  contract  should  secure  their  reward  by  way  of  recog- 
nition of  efficient  management  in  fixing  the  rate  of  return. 
In  a  purchase-and-sale  case  such  a  contract  may  be  prop- 
erly valued  to  the  extent  of  its  probable  effect  upon  the  rate 
of  return,  the  advantages  of  operating  without  a  capital 
investment,  and  such  other  similar  items  as  may  give  it  a 
market  value. 

There  is,  it  is  true,  a  line  of  decisions  holding  that  the 
advantages  from  such  a  contract  constitute  a  value  that  is 
properly  included  in  the  rate  base.2  It  is  suggested,  however, 

1  Greensburg  v.  Westmoreland  Water  Co.  (Pa.)  P.U.R.  1917-D-478, 
533. 

2  Bonbrigkt  c.  Corporation  Comm.  of  Arizona,  210  Fed.  44,  reversing 


154  FAIR  VALUE 

that  these  cases  confuse  market  value  with  rate  value  and 
may  properly  be  disregarded. 

The  case  is  somewhat  different  where  the  utility  has  pur- 
chased an  easement  or  acquired  riparian  rights.  Such  rights 
represent  an  actual  investment,  an  expenditure  in  advance 
of  receipt  of  the  service  and  usually  not  proportionate 
thereto.  They  constitute  a  proper  capital  charge,1  to  be 
amortized  from  income  during  the  life  of  the  right. 

Valuation  of  this  type  of  water  rights  has  been  forcibly 
made  to  appear  a  vexing  problem.  Most  of  the  difficulties 
have  been  introduced  by  befogging  the  distinction  between 
original  cost,  reproduction  cost,  and  final  value.  The  original 
cost  of  such  water  rights,  assuming  their  reasonableness,  is 
the  amount  actually  expended  in  securing  them.  The  re- 
production cost  is  the  fair  market  value  of  the  right  or  the 
sum  that  would  have  to  be  expended  at  the  present  time  to 
secure  the  rights.  In  the  case  of  water  rights  accruing  by 
reason  of  ownership  of  land,  the  cost  of  the  right  is  merged 
in  that  of  the  land 2  and  the  original  cost  is  included  in  the 
investment  in  the  property,  the  reproduction  cost  is  the 
market  value  of  the  land. 

the  opinion  of  the  Commission  that  a  contract  was  not  a  proper  capital 
charge;  City  of  Ely  v.  Ely  Light  &  Power  Co.  (Nevada),  24  Comm.  Leaf. 
578;  etc. 

1  San  Joaquin  &  K.R.  Canal  &  Irrig.  Co.  v.  Stanislaus  County,  233 
U.S.  454,  58  L.  ed.  1041;  Public  Service  Comm.  v.  Pacific  Power  &  Light 
Co.  (Cal.)  P.U.R.  1915-A-88,  96;  Peck  v.  Indianapolis  Lighting  &  Heat- 
ing Co.  (Ind.)  P.U.R.  1916-B-445;  Portland  R.  L.  &  P.  Co.  (Or.)  1916- 
D-976;  Apple  v.  Brazil  (Ind.)  P.U.R.  1915-C-561;  Marin  Municipal 
Water  Dist.  (Cal.)  P.U.R.  1915-C-433.  See  also  Re  City  of  Santa  Cruz 
(Cal.)  1915-F-768,  where  such  value  was  allowed  in  a  valuation  for  pur- 
chase by  the  municipality. 

2  Re  San  Lorenzo  Water  Co.  (Cal.)  P.U.R.  1915-D-1091;  Re  City  of 
Redondo  Beach  (Cal.)  1915-B-429;  Campbell  v.  Hood  River  Gas  &  Elec. 
Co.  (Or.)  P.U.R.  1915-D-855;  Portland  Railway  L.  &  P.  Co.  (Or.)  P.U.R. 
1916-D-976.  Percolating  and  storm  waters  valued  with  land,  San  Gabriel 
Valley  Water  Co.  (Cal.)  1916-B-895;  and  Marin  Municipal  Water  Dist. 
(Cal.)  P.U.R.  1915-C-433.  The  Idaho  Commission  has  used  the  original 
method  of  valuing  the  land  with  the  water  right,  Sandpoint  Water  &  L. 
Co.  (Idaho)  P.U.R.  1915-F-445,  457. 


VALUATION  OF  TANGIBLE  PROPERTY    155 

The  final  valuation  must  represent  the  unimpaired,  rea- 
sonable investment  in  that  portion  of  the  water  rights 
which  is  used  or  useful  in  rendering  the  public  service.  Ex- 
cessive provision  for  the  future  must  be  excluded,  and,  in 
the  absence  of  statute  to  the  contrary,  undeveloped  water 
power  must  be  disregarded.1  And  where  the  rights  are  the 
result  of  government  franchise  only  the  amount  actually 
expended  in  developing  the  rights  can  be  capitalized.2 

An  ingenious  scheme  to  reap  rich  profits  from  water 
rights  for  power  use  was  developed  in  the  earlier  valuation 
cases.  Utility  advocates  argued  that  the  fair  value  of  a 
water  right  was  the  capitalized  saving  from  the  use  of  water 
power  as  compared  to  steam  power.  In  commenting  on  this 
theory,  in  Grafton  County  Electric  Light  and  Power  Com- 
pany,3 Commissioner  Niles  held  that  such  evidence  should 
not  be  regarded  as  important,  because  the  test  of  value  is 
not  the  profitable  use  which  can  be  made  of  the  powers  in 
the  particular  public  service,  but  the  market  value  of  the 
right,  taking  into  account  both  supply  and  demand.  To 
allow  any  class  of  property  used  in  the  public  service  to  be 
capitalized  at  more  than  its  actual  market  value,  the  Com- 
missioner pointed  out,  would  produce  the  absurd  result  of 
establishing  for  public  service  corporations  a  higher  basis 
of  capitalization  than  for  corporations  of  a  purely  private 
character.4 

»  Portland  Ry.  L.  &  P.  Co.  (Or.)  P.U.R.  1916-D-976. 

2  East  Bakersfield  Improvement  Association  v.  San  Joaquin  Light  & 
Power  Corp.  (Cal.)  P.U.R.  1916-C-830.  Thayer  v.  Beaver  Valley  Water 
Co.  (Pa.)  P.U.R.  1916-E-962. 

3  New  Hampshire  Pub.  Serv.  Comm.  P.U.R.  1916-E-879,  919. 

4  While  Re  Grafton  County  Elec.  Light  &  Power  Co.  is  a  purchase- 
and-sale  case,  the  remarks  are  applicable  to  the  reproduction-cost  ap- 
praisal rate-making,  since  market  value  is  sought  in  both  instances.  The 
Commission  said  in  part:  "We  cannot  admit  that  there  is  any  compulsory 
method  of  determining  the  value  of  a  water  power.  ...  Its  saving  to  the 
owner  over  some  more  expensive  method  of  power  production  does  not 
measure  its  selling  price,  or  value,  any  more  than  the  cost-of-reproduction 
method  determines  the  value  of  physical  structures,  simply  because,  as 
a  matter  of  fact,  water  powers  are  not  valued  and  do  not  sell  upon  that 


156  FAIR  VALUE 

The  Vermont  Public  Service  Commission,  in  considering 
the  saving-over-coal  method  of  valuing  water  rights  in 
Montpelier  and  Barre  Light  and  Power  Company,1  disap- 
proved that  method  of  valuation  as  a  basis  for  securities 
issues  because  it  creates  a  value  which  may  be  largely  in 
excess  of  the  actual  value  of  the  rights,  and  when  applied 
to  rates  deprives  the  consumer  of  all  benefits  from  natural 
resources. 

The  Oregon  Public  Service  Commission  rejected  the  sav- 
ing-over-coal method  in  Portland  Railway  Light  and  Power 
Company,2  because  the  value  sought  under  that  theory 
depends  upon  a  capitalized  saving,  and  the  cost  of  opera- 
tion varies  with  the  market  prices;  to  measure  by  this  the- 
ory, therefore,  would  be  to  measure  with  a  variable.  Its 
acceptance  would  deprive  the  community  of  one  of  its 

basis.  And  the  objection  of  the  Supreme  Court  to  the  conjectural  char- 
acter of  the  cost-of-reproduction  method  applied  with  equal  force  to  the 
'  saving-over-coal '  method  of  valuing  water  powers.  It  assumes,  what 
is  not  proved,  that  power  could  be  produced  profitably  by  coal.  And  it 
assumes,  what  is  not  true,  that  a  given  amount  of  power  produced  by 
water,  varying  in  amount  as  it  will  on  even  the  best  regulated  streams,  is 
equal  in  value  to  a  like  amount  of  power  generated  by  steam,  constant 
and  reliable  at  all  times.  .  .  .  One  feature  of  the  ' saving-over-coal' 
method  of  determining  the  value  of  a  water  power  should  not  escape 
attention.  We  live  in  a  region  remote  from  the  coal  fields,  the  cost  of  trans- 
portation is  heavy,  and  the  price  of  coal  is  higher  than  in  almost  any  other 
part  of  the  country.  On  the  other  hand,  ours  is  a  mountainous  State,  with 
many  streams  having  a  large  fall  and  furnishing  an  abundance  of  water 
power,  much  of  which  is  still  undeveloped.  If  we  adopt  the  policy  of 
valuing  water  power  in  rate  and  capitalization  cases  by  capitalizing  their 
saving  over  coal,  the  people  of  the  State  are  left  subject  to  all  the  dis- 
advantages attendant  on  remoteness  from  the  coal  mines,  while  enjoying 
no  advantage  from  living  in  a  region  abundantly  supplied  with  water 
powers."  See  also  Grafton  County  Electric  Light  &  Power  Company 
(N.H.  Sup.  Ct.)  P.U.R.  1917-E-345,  353;  Ocean  County  Electric  Com- 
pany (N.J.)  P.U.R.  1916-D-77;  and  Berlin  Electric  Light  Company 
8  N.H.  P.S.C.  174;  San  Joaquin  Light  &  Power  Corp.  v.  Railroad  Com- 
mission (Cal.  Sup.  Ct.)  P.U.R.  1917-E-37,  41;  Public  Service  Commis- 
sion v.  Pacific  P.  &  L.  Co.  (Wash.)  P.U.R.  1916-B-86,  93;  Rhinelander 
v.  Rhinelander  Lighting  Co.  9  W.R.C.R.  406. 

1  P.U.R.  1916-B-973,  976. 

8  P.U.R.  1917-D-962,  971. 


VALUATION  OF  TANGIBLE  PROPERTY    157 

natural  resources  and  permit  the  capitalization  of  that 
resource  for  the  sole  benefit  of  an  individual. 

The  fallacies  of  the  saving-over-coal  theory  are  set  forth 
in  the  cases  cited.  It  has  no  proper  sphere  in  valuation.  It 
does  not  show  original  cost.  It  does  not  determine  market 
value  or  reproduction  cost  because  it  considers  only  the 
supply,  not  the  demand  side.  It  is  conjectural.  And  it 
defeats  regulation  by  granting  public  service  companies 
a  higher  basis  of  capitalization  than  private  industries 
enjoy. 

XL  Pavement  over  Mains 

The  question  of  capital  charges  for  cutting  and  replacing 
pavements  over  water  and  gas  mains  and  services  and  elec- 
tric ducts  plays  a  comparatively  unimportant  part  in  the 
original-cost  appraisal.  Only  paving  actually  cut  and  re- 
placed in  the  installation  of  mains  is  involved,  and  the  ex- 
penditures for  this  work  represent  necessary  and  unavoid- 
able investment.1 

The  reproduction-cost  appraisal,  however,  raises  the 
question  of  the  propriety  of  allowing  in  rate  valuations  for 
paving  not  actually  cut  and  replaced,  but  which  would 
have  to  be  cut  if  the  plant  were  to  be  reconstructed  under 
present  conditions.  The  strict  theory  of  the  reproduction- 
cost  appraisal  if  adhered  to  would  include  such  costs.  But 
for  reasons  already  stated  reproduction  cost  cannot  be  used 
without  modification  for  rate  valuation  even  as  an  appraisal 
theory.  The  reproduction  cost  appraisal  is  not  an  end  in  it- 
self. It  serves  only  as  a  check  upon  and  supplement  to  the 
original-cost-to-date  estimate,  not  as  a  substitute  for  that 
appraisal.  The  form  of  the  reproduction-cost  appraisal 
must  be  fitted  to  the  limitations  placed  upon  its  use.  The 
cost  of  cutting  and  replacing  pavement,  therefore,  can  be 
included  in  the  estimated  cost  of  reproduction  only  when 

1  The  Commissions'  decisions  are  unanimous  in  allowing  for  paving 
actually  cut. 


158  FAIR  VALUE 

the  paving  was  actually  cut.1  To  hold  otherwise  would  in- 
capacitate the  reproduction-cost  appraisal  for  the  service 
it  must  perform  because  it  would  result  in  figures  neither 
a  check  upon  nor  supplemental  to  original  cost.  Such 
figures  can  have  no  place  in  the  final  valuation. 

Justice  Day,  of  the  United  States  Supreme  Court  in  con- 
sidering this  question  in  the  Des  Moines  Gas  Case,2  said: 

These  pavements  were  already  in  place.  It  may  be  conceded 
that  they  would  require  removal  at  the  time  when  it  became  nec- 
essary to  reproduce  the  plant  in  this  respect.  The  master  reached 
the  conclusion  that  the  life  of  the  mains  would  not  be  enhanced 
by  the  necessity  of  removing  the  pavements,  and  that  the  com- 
pany had  no  right  of  property  in  the  pavement  thus  dealt  with, 
and  that  there  was  neither  justice  nor  equity  in  requiring  the  peo- 
ple who  had  been  at  the  expense  of  paving  the  streets  to  pay  an 
additional  sum  for  gas  because  the  plant,  when  put  in,  would  have 
to  be  at  the  expense  of  taking  up  and  replacing  the  pavements  in 
building  the  same.  He  held  that  such  added  value  was  wholly 
theoretical,  when  no  benefit  was  derived  therefrom.  We  find  no 
errors  in  this  disposition  of  the  question. 

This  ruling  has  been  followed  by  all  the  commissions. 

Cost  based  on  undisturbed  paving,  despite  the  claims  of 
reproduction-cost  advocates,  has  no  place  in  a  valuation 
for  rate-making  purposes.  It  has  been  argued,  however,  that 
mains  laid  under  pavement  are  intrinsically  more  valuable 
than  those  in  unpaved  streets  because  the  greater  the  extent 

1  The  Commissions  of  California,  Illinois,  Indiana,  Missouri,  New 
York,  Ohio,  and  Wisconsin  have  repeatedly  held  that  paving  not  actually 
cut  cannot  be  included  even  in  the  reproduction-cost  appraisal.  Com- 
missioner Maltbie,  of  New  York,  expressed  the  State  Commission's  stand 
in  Mayhew  v.  Kings  County  Lighting  Company,  2  P.S.C.  (N.Y.  1st  Dist.) 
659,  thus:  "In  other  words,  every  time  the  streets  are  improved,  not  only 
do  taxes  or  assessments  go  up,  but  higher  gas  rates  are  justified,  notwith- 
standing the  fact  that  the  company  may  not  have  paid  one  dollar  in  con- 
nection therewith.  If  this  theory  is  correct,  citizens  must  consider  in 
connection  with  every  civic  improvement  its  effect  upon  rates  for  gas, 
electricity,  telephone  service,  water,  transportation,  and  every  other 
service  which  involves  the  use  of  the  subsurface  of  the  streets." 

2  Des  Moines  Gas  Company  v.  Des  Moines,  238  U.S.  153,  P.U.R.  1915- 
D-589,  590,  59  L.  ed.  1244. 


VALUATION  OF  TANGIBLE  PROPERTY    159 

to  which  a  distribution  system  is  located  under  paved 
streets,  the  greater  would  be  its  value,  in  the  eye  of  a  pur- 
chaser. 

This  argument  is  fallacious  in  assuming  that  rate  value 
must  include  all  elements  making  up  purchase  value.  Rate 
value  attempts  to  determine  value  as  an  element  in  cost  of 
service,  and  uncut  paving  cannot  in  any  conceivable  man- 
ner affect  cost  of  service.  The  conclusion  of  the  argument  is, 
moreover,  as  erroneous  as  the  premises.  A  statement  that 
the  value  of  mains  laid  under  pavement  is  in  general  less 
than  that  of  those  over  which  there  is  no  pavement  would 
probably  have  been  more  accurate.  Repairs  to  mains,  serv- 
ices, and  ducts  become  more  difficult  and  costly  after  pav- 
ing is  laid;  connection  of  services  is  more  expensive;  greater 
time  is  required  for  making  emergency  repairs  and  improve- 
ments; property  owners  having  frontage  on  the  street  dis- 
turbed are  aggravated;  special  permits  have  to  be  secured; 
and  innumerable  similar  disadvantages  add  to  the  cost  of 
utility  service  where  the  mains  lie  under  paved  streets. 

The  issue  is,  What  is  the  unimpaired  investment  in  mains 
upon  which  the  stockholder  can  reasonably  expect  a  re- 
turn for  his  sacrifice.1 

XII.  Summary 

Valuation  of  the  tangible  property  of  a  utility  for  rate- 
making  seeks  to  determine  the  actual,  reasonable,  unim- 
paired investment  in  that  portion  of  the  tangible  property 
which  is  used  or  useful  in  rendering  the  public  service.  Prop- 
erty acquired  without  cost  cannot  be  included  in  the  final 
valuation  because  it  is  not  investment  and  represents  no 
sacrifice  for  which  the  stockholder  is  entitled  to  a  return. 
Property  acquired  from  surplus  is  properly  included  in  a 

1  It  is  commonly  held  that  the  cost  of  uncut  paving  is  not  a  proper 
charge  in  a  valuation  for  purchase  and  sale.  Appleton  Water  Works  Com- 
pany, 6  W.R.C.R.  97,  122,  Affd.  154  Wis.  121;  Manitowoc  Water  Works 
Company,  7  W.R.C.R.  71;  Oshkosh  Water  Works  Plant,  12  W.R.C.R. 
602;  etc. 


160  FAIR  VALUE 

rate  valuation,  though  the  Commissions  are  not  agreed 
upon  this  point.  Land  should  be  valued  at  its  cost  in  the 
original-cost  appraisal  and  at  the  market  value  of  similar 
neighboring  real  estate  in  the  reproduction-cost  estimate. 
The  final  valuation  must  be  premised  upon  the  investment 
as  in  the  case  of  other  tangible  property. 

Buildings  upon  the  land  unsuitable  for  utility  purposes 
and  removed  add  to  its  value  the  cost  of  removal  less  their 
salvage  value.  But  the  reproduction-cost  appraisal  must  be 
limited  in  this  regard  to  actual  conditions  at  the  time  of 
purchase  to  exclude  conjectural  results  and  fit  the  repro- 
duction-cost estimate  to  serve  as  a  check  upon  and  supple- 
ment to  the  original-cost  appraisal. 

Contracts  for  water  service  are  not  capital  charges,  but 
easements  and  water  rights  vesting  with  the  title  to  the 
land  are  and  must  be  included  in  the  valuation  for  rate- 
making  or  for  purchase  and  sale.  Here  too  the  attempt  is  to 
determine  investment,  but  the  market  value  of  the  right  is 
properly  included  in  the  reproduction-cost  appraisal.  The 
saving-over-coal  theory  of  water-rights  valuation  is  im- 
proper in  all  cases. 

Pavement  over  mains  is  legitimately  valued  for  rate- 
making  when  the  pavement  was  actually  cut  and  properly 
replaced.  But  such  costs  are  not  properly  included,  even  in 
the  reproduction-cost  appraisal  where  the  pavement  was 
laid  after  the  mains  were  placed.  There  has  been  no  real  in- 
vestment in  such  cases  and  valuation  seeks  primarily  to 
determine  investment. 


CHAPTER  VII 
VALUATION  OF  INTANGIBLE  PROPERTY 

I.  Overhead  Charges 

The  most  disputed  field  in  public-utility  valuation  is  the 
allowance  for  intangible  values,  and  the  most  mooted  ques- 
tion that  of  overhead  expenses.  The  bare  construction  cost 
of  the  physical  plant  and  equipment  does  not  include  all 
the  justifiable  actual  capital  expenditures  of  the  company. 
Funds  are  legitimately  spent  in  prospecting  in  an  under- 
taking of  any  magnitude,  in  determining  the  possibilities 
for  profit  and  the  risks  in  the  undertaking.  The  project  can 
seldom  be  carried  out  without  considerable  expenditures 
for  promotion  and  financing.  Engineering  and  legal  advice 
are  always  necessary  and  the  fees  therefor  usually  are  a 
proper  capital  charge.  Working  capital  must  be  provided. 
Interest  must  be  paid  on  the  investment  up  to  the  time 
operations  are  started,  taxes  must  be  met,  and  insurance 
carried  from  capital  funds  till  income  begins.  And  there  are 
numerous  other  similar  charges  any  or  all  of  which  may  have 
to  be  met.  Such  expenses,  when  reasonable  and  not  a  mere 
increase  in  the  interest  on  the  funds  invested,  or  a  part  of 
the  operating  expenses,  represent  actual  necessary  invest- 
ment in  property  used  and  useful  in  rendering  the  utility 
service,  and  are  properly  included  in  the  valuation.1 

Overhead  expenses  must  be  met  in  the  original  construc- 
tion of  the  plant;  but  in  making  the  original-cost  inventory 
it  is  often  found  that  a  large  part  of  the  expenditures  of 
this  nature  have  been  entered  on  the  utility  company's 
books  with  the  physical  items  to  which  they  attach,  as  capi- 
tal or  in  the  operating  accounts.  In  such  cases  a  separate 

1  The  State  Commission  decisions  without  exception  allow  for  over- 
head expenses  actually  incurred  in  the  original-cost  appraisal  and  those 
reasonably  necessary  in  the  reproduction-cost  appraisal. 


162  FAIR  VALUE 

allowance  for  these  items  would  result  in  duplication,  and 
create  a  capital  charge  representing  no  actual  investment. 
Aside  from  liability  of  duplication,  the  original-cost  ap- 
praisal presents  few  difficulties. 

The  reproduction-cost  estimate,  however,  raises  numer- 
ous questions  as  to  overhead  allowances.  It  permits  in  gen- 
eral of  much  higher  overheads  than  the  original-cost  ap- 
praisal. The  items  are  conjectural,  and  it  seems  to  be  the 
rule  that  engineers  who  submit  high  valuations  of  the  phys- 
ical property  also  surcharge  the  thus  already  high  appraisal 
with  an  undue  percentage  to  cover  overhead  expenses.  The 
following  list  of  overhead  items  suggested  by  an  engineer 
in  a  case  before  the  Illinois  Public  Utilities  Commission,1 
is  not  exceptional: 

1.  Under  organization  costs  — 

(a)  Cost  of  preliminary  business  investigation  and  nego- 
tiations. 

(b)  Expert  preliminary  engineering  reports  in  the  gen- 
eral character  and  cost  of  proposed  system. 

(c)  Incorporation  costs  including  charter  fees  and  cost 
of  issuing  and  selling  stock. 

(d)  Legal  advice. 

(e)  Special  engineering  investigations  for  source  of  wa- 
ter supply. 

(f)  Cost  of  sinking  test  wells  and  pits. 

(g)  Cost  of  determining  density  of  population  and  of 
probable  motor  and  light  load. 

(h)  Cost  of  optioning  real  estate. 

(i)  Cost  of  printing  and  issuing  bonds  and  arranging 
for  their  sale. 

(j)  And,  in  general,  all  cost  incident  to  putting  enter- 
prise on  a  definite  basis  up  to  the  point  where  de- 
tailed plans  can  be  prepared  and  actual  construction 
begun. 

2.  Under  engineering  and  superintending  costs  — 

(a)  Salaries  and  expenses  of  engineering  and  superin- 
tending force. 

1  Lincoln  v.  Lincoln  Water  &  L.  Co.  Valuation  by  Maury.  I.P.U.C. 
No.  2496  P.U.R.  1917-B-l. 


VALUATION  OF  INTANGIBLE  PROPERTY    163 

(b)  Preparation  of  detailed  plans. 

(c)  Preparation  of  specifications. 

(d)  Preparation  and  letting  of  contracts. 

(e)  Setting  of  lines  and  grades. 

(f)  Inspection  of  work. 

(g)  Estimates  for  contractors. 

(h)  Purchase  of  material  and  supervision  of  labor  where 

work  is  not  done  by  contract, 
(i)  Final  tests  and  adjustment  of  contracts, 
(j)  The  placing  of  the  plant  in  successful  operation. 
S.  Under  general  administrative  and  legal  costs  — 

(a)  Salaries  of  general  officers. 

(b)  Salaries  and  expenses  of  office  assistants. 

(c)  Cost  of  accounting. 

(d)  Legal  advice. 

(e)  Rent  and  office  expense. 

4.  Under  general  contingent  cost  during  construction  — 

(a)  Changes  in  construction  due  to  unforeseen  obstacles 
developed  during  the  progress  of  the  work. 

(b)  Rise  in  prices  of  material  or  labor  above  normal. 

(c)  Financial  panics. 

(d)  Inclement  weather  causing  delays. 

(e)  Floods  causing  both  an  actual  property  loss  and  un- 
avoidable delays. 

(f)  Failure  of  contractors. 

(g)  Especial  unforeseen  difficulties  encountered  in  deep 
excavations. 

(h)  Strikes. 

(i)  Litigation. 

(j)  Taxes  and  assessments  on  real  estate  and  personal 
property  for  two  years. 

(k)  Insurance. 

(1)  Cost  of  temporary  drive  wells  and  pumping  plant 
to  supply  the  city  before  the  permanent  plant  is 
completed, 
(m)  Cost  of  selling  construction  bonds,  including  com- 
mission or  discounts. 

5.  Under  interest  construction  — 

(a)  Being  6  per  cent  interest  on  the  moneys  expended 
progressively  for  construction  until  the  plant  begins 
operation  and  such  charges  may  be  carried  in  the 
operating  accounts. 


164  FAIR  VALUE 

It  is,  of  course,  inconceivable,  even  in  the  face  of  the 
serious  suggestion  of  the  appraiser,  that  all  these  overheads 
should  be  encountered  in  the  actual  construction  of  each 
plant.  Clearly  all  should  not  be  included  in  the  hypothetical 
reconstruction.  An  inventory  based  on  possible  or  even 
probable  overheads  rather  than  those  actually  encountered 
would  produce  the  conjectural  appraisal  rejected  in  the 
Minnesota  Rate  Cases.  If  it  were  seriously  contended  that 
such  overlapping  and  exaggerated  expenses  would  be  actu- 
ally encountered,  the  resultant  figure  would  have  to  be  ex- 
cluded from  the  rate  base  in  any  case,  for  only  the  reasona- 
ble cost  can  be  considered.  Mistakes  in  judgment,  unneces- 
sary duplication,  and  unwarranted  expenditures  form  no 
part  of  the  value  for  rate-making.  Such  an  appraisal  would 
lead  to  a  reproduction-cost  appraisal  unfit  to  fulfill  its  pur- 
pose in  valuation.  It  should  serve  as  a  check  upon  and  sup- 
plement to  the  original-cost  appraisal,  and  to  enable  it  to 
do  this  the  overheads  allowed  must  be  based  upon  fact, 
not  imagination.1 

It  is  necessary  in  determining  a  reasonable  allowance 
for  overhead  expenses  to  consider  the  general  characteris- 
tics of  a  property  and  the  efficiency  of  its  operation.  Over- 
head expenses,  to  a  large  extent,  represent  skill,  judgment, 
and  ingenuity  during  the  preparatory  and  construction  pe- 
riod. That  skill  and  judgment  should  have  been  paid  for  in 
proportion  to  value  received,  and  would  have  to  be  so  paid 
in  case  of  reproduction  if  the  payments  were  to  be  properly 
included  in  the  valuation  for  rate-making  purposes.  This 
is  particularly  true  in  regard  to  engineering  and  supervision. 
If  the  usual  fees  for  such  services  are  to  be  allowed,  the  re- 
sults of  the  service  should  be  apparent.  A  five  per  cent  al- 
lowance seems  small,  but  it  must  be  remembered  that  a 
claim  for  engineering,  amounting  to  five  per  cent  of  the  total 
tangible  property,  is  equivalent  to  a  far  greater  percentage 

1  Herman  v.  Newton  Gas  Co.  (N.Y.  1st  Dist.)  P.U.R.  1916-D-825; 
Mantua  Twp.  ».  New  Jersey  Gas  Co.  (N.Y.)  P.U.R.  1916-C-163;  etc. 


VALUATION  OF  INTANGIBLE  PROPERTY    165 

on  the  items  which  actually  require  engineering  attention. 
Five  per  cent,  therefore,  is  a  very  remunerative  fee  for  either 
engineering  or  supervision.  A  plant  constructed  piecemeal 
during  a  long  period  cannot  be  valued  for  rate-making  with 
the  same  allowance  for  overheads  as  a  plant  constructed 
as  a  single  unit  on  definitely  worked-out  plans.  Large  per- 
centages for  overheads  can  be  allowed  only  when  the  prop- 
erty is  very  compact,  exceptionally  efficient,  and  highly 
suitable  for  present-day  requirements. 
|  Much  of  the  conjectural  element  in  reproduction-cost 
appraisals  has  been  needlessly  drawn  into  valuation  work 
by  the  failure  of  appraisers  to  recognize  or  acknowledge 
the  difference  between  the  appraisal  and  the  estimate;  be- 
tween determining  the  cost  of  reproducing  a  plant  of  known 
character  under  fixed  conditions  and  estimating  the  cost 
of  producing  a  plant  of  similar  character.  The  reproduction- 
cost  appraisal  involves  no  real  construction.  The  whole 
process  is  purely  imaginary.  The  items  which  make  up  the 
property  are  before  the  appraiser  and  susceptible  of  abso- 
lute determination.  The  conditions  under  which  those  items 
are  to  be  installed  are  definitely  and  exactly  prescribed.  In 
the  estimate  of  construction  cost  the  material  to  be  used  is 
conjectural,  depending  upon  unforeseeable  contingencies 
developing  during  the  process  of  construction.  The  condi- 
tions of  installation  cannot  be  foretold  with  absolute  accu- 
racy. The  uncertainty  involved  necessitates  a  contingency 
allowance  and  liberal  overheads  where  actual  construction 
along  variable  lines  is  contemplated.  Engineers  have  almost 
invariably  applied  estimate  methods  to  the  appraisal,  and 
widened  the  gap  between  original  and  reproduction  cost. 

In  either  the  original-cost  or  reproduction-cost  appraisal 
the  allowance  for  overhead  must  be  made  upon  the  depre- 
ciated value  of  the  property,  or  the  allowance  itself  be  de- 
preciated to  arrive  at  present  value  or  unimpaired  invest- 
ment. *  If  such  allowances  were  not  depreciated  or  amortized 

1  Washington  &  M.  R.  Co.  (D.C.)  P.U.R.  1915-B-558;  Campbell  v. 


166  FAIR  VALUE 

a  capital  charge  would  remain  and  receive  a  return  from 
rates  after  the  investment  had  ceased  to  be  used  or  useful. 
Depreciation  rather  than  amortization  is  the  remedy,  for 
the  expenditures  are  a  capital  charge. 

II.  Organization  Expenses 

The  first  overhead  charge  encountered  is  organization  ex- 
pense. It  includes  all  the  expenditures  necessary  in  bringing 
about  the  decision  to  undertake  the  enterprise.  The  law 
holds  the  utility  responsible  for  all  mistakes  in  judgment, 
poor  location,  over-construction,  faulty  organization,  etc., 
and  allows  only  a  fair  rate  on  a  reasonable  capitalization 
irrespective  of  actual  investment.  The  utility,  therefore,  is 
justified  in  making  any  reasonable  outlay  for  salaries  of 
officials  engaged  in  bringing  men  and  material  into  the  in- 
dustry, the  preliminary  expenses  connected  with  prospect- 
ing, determination  of  the  demand  for  service  and  probable 
number  of  consumers,  the  quality  of  service  desired,  ascer- 
taining operating  conditions,  availability  of  water  power, 
fuel,  etc.,  securing  options  on  suitable  property,  deter- 
mining the  cost  of  construction,  and  paying  for  corporate 
organization,  oflice  expenses,  legal  services,  etc.  These  ex- 
penditures constitute  actual,  necessary,  and  useful  in- 
vestments. The  propriety  of  including  such  sums  in  the 
valuation  cannot  be  questioned.  The  State  Commissions 
have  universally  allowed  such  elements  of  value.  But  the 
California  Commission  has  rejected  organization  expenses 
incurred  in  connection  with  the  building-up  of  a  predecessor 
company  on  the  ground  that  such  expenses  were  of  no  bene- 
fit to  consumers  of  the  existing  company.1 

Hood  River  G.  &.  E.  Co.  (Or.)  P.U.R.  1915-D-855;  Portland  R.  L.  &  P. 
Co.  (Or.)  P.U.R.  1916-D-976;  Rates  of  Missouri  So.  R.  Co.  (Mo.)  P.U.R. 
1916-C-607;  Re  Central  P.  R.  Co.  (Cal.)  P.U.R.  1916-B-845;  Re  Los 
Angeles  (Cal.)  P.U.R.  1916-F-563;  Mountain  States  T.  &  T.  Co.  (Col.) 
P.U.R.  1917-B-198.  Contra,  see  Lima  v.  Lima  T.  &.  T.  Co.  (Ohio)  P.U.R. 
1916-E-670. 

1  Salinas  City  v.  Coast  Valley  Gas  &  Elec.  Co.  (Cal.)  P.U.R.  1915-B- 
460. 


VALUATION  OF  INTANGIBLE  PROPERTY    167 

III.  Promoters'  Profits 

Organization  costs,  however,  must  be  distinguished  from 
promoters'  profits.  The  State  Commissions  are  by  no  means 
agreed  upon  the  propriety  of  including  such  expenditures 
in  the  valuation.  There  would  seem  to  be  little  room  for  dis- 
pute, so  far  as  the  theory  of  such  expenses  is  concerned, 
though  there  is  ample  room  for  confusion  in  practice.  The 
promoter  performs  a  necessary  and  useful  function.  With- 
out his  efforts  the  undertaking  would  often  be  impossible. 
Neither  the  consumers  nor  the  investors  are  equipped  to 
perform  the  promoter's  task.  If  either  undertook  it,  the 
work  would  be  faultily  performed  at  a  greater  expense,  if 
accomplished  at  all;  and  the  resulting  organization  in  nine 
out  of  ten  cases  would  be  less  stable.  The  promoter  assumes 
risks  relatively  large  and  intense.  His  return  must  be  pro- 
portionately great.  Ability  of  the  highest  order,  good  stand- 
ing, and  financial  backing  are  required  and  must  be  paid 
for.  His  reward  for  service  and  risk  represents  real  invest- 
ment, beneficial  to  the  company  if  necessary  under  the  cir- 
cumstances, whether  it  was  paid  for  with  stock  or  money. 
The  past,  however,  has  been  replete  with  examples  of  un- 
scrupulous, unwarranted  if  not  illegal,  promotional  specu- 
lations. A  limitation,  therefore,  must  be  placed  upon  such 
allowances.  Promoters'  profits  can  be  included  in  the  valua- 
tion only  upon  a  showing  of  reasonable  necessity  and  a  re- 
sulting benefit  to  the  service.1 

IV.  Interest  during  Construction 

A  public-utility  plant  cannot  be  constructed  in  any  brief 
space  of  time.  The  material  and  labor  must  be  collected, 

1  Edwards  v.  Glen  Tel.  Co.  (N.Y.  2d  Dist.)  P.U.R.  1916-B-940;  Bay 
State  Rate  Case  (Mass.)  P.U.R.  1916-F-221;  Pine  Lawn  v.  West  St. 
Louis  Water  &  L.  Co.  (Mo.)  P.U.R.  1917-B-679;  etc.  Such  expenses  are 
excluded  in  case  of  financing  of  a  subsidiary  company  by  the  parent 
utility.  See  Herman  v.  Newton  Gas  Co.  (N.Y.  1st  Dist.)  P.U.R.  1916-D- 
825;  Chesapeake  v.  P.  Tel.  Co.  (Md.)  P.U.R.  1916-C-925;  Mountain 
States  T.  &  T.  Co.  (Col.)  P.U.R.  1917-B-198;  etc. 


168  FAIR  VALUE 

plans  drawn,  and  months  spent  in  actual  construction  work. 
The  funds  employed  in  this  work  draw  no  return  prior  to 
the  date  of  operation.  The  capital  invested  is  necessarily 
idle,  and  produces  no  return.  The  investor  makes  a  real 
sacrifice  in  foregoing  interest  during  that  period,  and  the 
interest  foregone  during  construction,  organization,  etc., 
up  to  the  time  of  operation  is  a  necessary  and  legitimate 
part  of  the  construction  expense.  Such  charges  represent 
an  actual  investment,  used  and  useful  in  the  utility  busi- 
ness. They  have  added  to  the  sale  value  and  the  produc- 
tive value  of  the  property,  and  the  State  Commissions, 
without  exception,  hold  that  within  reason  interest  during 
construction  is  properly  included  in  the  valuation. 

Interest  during  construction  as  a  capital  charge  is  lim- 
ited, however,  to  a  reasonable  amount.1  Two  issues  are 
presented : 

(1)  What  is  the  fair  rate  of  interest?  (2)  What,  under 
the  actual  circumstances  involved,  is  the  proper  length  of 
time  during  which  interest  is  to  be  allowed? 

The  rate  of  interest  fixed  cannot  be  the  same  in  every 
case.  Even  if  the  current  rate  under  similar  risk  is  accepted 
as  the  gauge,  the  sum  will  vary  in  different  sections  of  the 
country.  But  that  rate  cannot  properly  be  accepted  as  the 
guide  outside  the  reproduction-cost  inventory.  The  actual 
rate  at  which  the  utility  was  able  to  borrow  must  govern 
whenever  it  can  be  ascertained,  and  it  always  can  be  when 
notes  or  bonds  were  issued. 

The  question  of  the  length  of  time  during  which  interest 
is  to  be  allowed  is  equally  important  in  the  reproduction 
inventory.  The  best  that  can  be  produced,  and  all  that  the 
reproduction  estimate  demands,  is  a  fairly  accurate  guess. 
The  economist  who  demands  absolute  figures  to  the  exclu- 
sion of  all  estimates  and  generalities  in  the  reproduction 

1  Petaluma  &  S.  R.R.  Co.  (Cat)  P.TJ.R.  1915-C-742;  Columbia  v. 
Watts  Engineering  Co.  (Mo.)  P.U.R.  1915-B-921;  Lincoln  v.  Lincoln 
Water  &  L.  Co.  (111.)  P.U.R.  1917-B-l;  etc. 


VALUATION  OF  INTANGIBLE  PROPERTY    169 

inventory  advocates  a  Utopian  appraisal  that  disclaims 
all  familiarity  with  actual  valuation  practice.  The  repro- 
duction inventory  is  an  estimate  based  on  supposition,  not 
fact,  limited  along  many  lines  to  prevent  too  wild  flights 
of  fancy,  but  a  guess  at  best.  It  claims  to  be  no  more.  Value 
is  itself  but  an  estimate,  and  commercial  appraisal  embraces 
all  the  irregularities  of  regulative  valuation.  Unquestion- 
able figures  cannot  be  expected  in  the  reproduction-cost 
inventory.  The  length  of  time  necessary  to  reconstruct  the 
hypothetical  plant  under  arbitrarily  assumed  conditions 
at  equally  arbitrarily  averaged  prices  must  be  estimated. 
To  make  the  estimate,  a  rate  of  construction  must  be  as- 
sumed which  must  in  turn  be  governed  by  the  conditions 
accepted  as  prevailing,  the  size  and  character  of  the  plant, 
the  surrounding  conditions,  etc.1  When  the  period  of  con- 
struction is  assumed  to  be  less  than  a  year,  it  is  generally 
taken  for  granted  that  the  whole  sum  needed  in  the  work 
will  be  procured  before  operations  are  begun -and  interest  is 
allowed  for  the  entire  construction  period.  But  when  the 
properties  are  large  and  the  period  of  plant  construction  is 
estimated  to  extend  over  several  years,  it  is  universally  as- 
sumed that  the  funds  will  not  all  be  provided  in  advance 
of  operations.  Actual  conditions  are  approximated  by  as- 
suming that  half  of  the  money  is  required  for  the  full  con- 
struction period,  or  that  all  of  the  funds  are  required  for 
half  of  that  time;  and  the  interest  is  figured  accordingly.2 
Six  per  cent  has  been  a  common  allowance  for  interest. 

1  All  this  guess-work  is  of  course  deplorable  and  would  be  truly  dan- 
gerous if  the  reproduction  inventory  had  not  been  discredited.  Yet  as  a 
check  such  an  appraisal  is  valuable.  It  is  on  just  such  estimates  as  this 
that  purchase  and  sale  are  based  in  the  unregulated  industrial  world, 
and  ordinary  cost  accounting  for  price-making  rests  upon  such  untrust- 
worthy valuations. 

2  State  Journal  Printing  Co.  v.  Madison  Gas  &  E.  Co.,  4  W.R.C.R. 
501;  Mayhew  v.  Kings  County  Lighting  Co.,  2  P.S.C.  (1st  Dist.  N.Y.) 
659;  Meek  v.  Consumers'  Elec.  L.  &  P.  Co.  (Mo.)  P.U.R.  1915-A-956; 
Washington  &  M.  R.  Co.  (D.C.)  P.U.R.  1915-B-558;  Columbia  v.  Watts 
Engineering  Co.  (Mo.)  P.U.R.  1915-B-921;  see  valuation  in  Minnesota 
Rate  Cases,  184  Fed.  765;  etc. 


170  FAIR  VALUE 

The  rate  of  interest  which  the  funds  accumulated  for 
construction  purposes  could  earn  as  average  balances  on 
deposit  against  a  checking  account  or  certificates  of  deposit 
may  properly  be  figured  as  a  set-off  against  the  claim  for 
interest  during  construction.  Such  a  charge  may  be  esti- 
mated on  the  half-year  basis  in  the  same  manner  that  the 
item  it  is  balanced  against  is  computed 

Taxes  must  be  paid  on  real  estate  and  personal  property 
even  before  construction  work  is  started.  Like  interest  they 
constitute  a  legitimate  capital  charge,  and  are  properly  in- 
cluded in  the  valuation x  in  the  amount  paid  up  to  the  time 
that  operation  starts;  and  they  may  be  cared  for  as  an  op- 
erating expense.  The  amount  of  this  charge  may  be  com- 
puted with  fair  accuracy,  even  in  the  absence  of  complete 
records,  from  the  local  tax  rate,  capital-stock  tax,  mortgage 
tax,  etc.,  all  of  which  may  be  readily  learned. 

Fire,  casualty,  and  other  insurance  on  the  plant  and 
equipment  during  the  pre-operating  period,  like  taxes  and 
interest,  must  be  met  from  capital;  and  the  sums  thus  ex- 
pended may  properly  be  included  in  the  valuation  as  a  sac- 
rifice or  necessary  investment  in  property  used  and  useful 
in  rendering  the  service.2 

V.  Engineering  and  Superintendence 

The  public  utility  in  the  process  of  construction  must 
make  multitudinous  expenditures  for  architectural  assist- 
ance and  engineering  advice,  designs,  drafts,  plans,  and 
the  numerous  matters  involved  in  construction  engineering. 
The  architect  must  prepare  and  submit  preliminary  studies, 
drawings,  specifications,  and  detailed  drawings;  and  must 
supervise  the  work  itself.  Engineering  and  superintendence 
expenditures  necessarily  begin  at  the  earliest  conception 

1  Re  Metropolitan  St.  Ry.  Co.  Reorganization,  3  P.S.C.  (1st  Dist. 
N.Y.)  113;  Columbia  v.  Watts  Engineering  Co.  (Mo.)  P.U.R.  1915-B- 
921;  Racine  Water  Co.  (Wis.)  P.U.R.  1917-D-277. 

2  Re  Metropolitan  St.  Ry.  Co.  Reorganization,  3  P.S.C.  (1st  Dist.  N.Y.) 
113;  Roundup  v.  Roundup  Coal  Min.  Co.  (Mont.)  P.U.R.  1916-D-393. 


VALUATION  OF  INTANGIBLE  PROPERTY    171 

of  the  undertaking  and  precede  the  actual  start  of  construc- 
tion. They  continue  until  the  construction  work  is  com- 
pleted. The  interest  of  both  the  investor  and  the  public 
demand  that  competent  engineering  and  superintendence 
service  be  secured  to  guarantee  efficiency  and  economy. 
The  reasonable  expenditures  for  these  services,  therefore, 
are  properly  made  a  part  of  the  regulatory  valuation.1 

Where  the  original  cost  of  engineering  can  be  ascertained, 
these  figures  should  control  over  any  hypothetical  repro- 
duction-cost estimate,  for  they  show  the  real  investment. 
When  reproduction  cost  is  sought,  resort  is  had  to  the  per- 
centage allowance.  This  method  has  been  severely  criticized, 
but  in  most  cases  the  critic  has  lost  sight  of  the  fact  that 
the  guess  occurs  in  an  appraisal  which  is  itself  but  a  guess, 
and  not  in  the  final  valuation.  The  use  of  percentage  allow- 
ances for  these  particular  items  is,  in  fact,  more  justifiable 
than  elsewhere,  for  both  architects  and  engineers  in  actual 
practice  figure  their  fees  on  the  percentage  basis.  The  ap- 
praiser merely  substitutes  his  percentage  figures  for  those 
of  the  imaginary  engineer.  The  percentage  used  by  the 
State  Commissions  has  varied,  but  it  is  suggested  that  the 
divergency  is  no  greater  than  that  which  would  appear  in 
actual  practice  in  the  figures  of  several  engineers;  andregula- 

1  The  State  Commissions'  decisions  are  unanimous  in  making  allow- 
ance for  reasonable  engineering  and  superintendence  charges,  but  there 
is  some  disagreement  as  to  the  form  of  the  allowance.  The  point  has  been 
raised  that  engineering  and  architectural  expenses  are  not  involved  in 
connection  with  every  form  of  property.  See  cases  excluding  engineering 
expenses  on  specified  items  such  as  furniture,  fixtures,  tools,  teams, 
meters,  etc.  Simms  v.  Columbia  Tel.  Co.  (Mo.)  P.U.R.  1915-C-366;  Re 
Racine  Water  Co.  (Wis.)  P.U.R.  1917-D-277;  Cripple  Creek  Water  Co. 
(Col.)  P.U.R.  1916-C-788;  etc.  The  general  percentage  allowance,  how- 
ever, has  been  uniformly  applied  in  a  majority  of  cases  because  that  is 
the  form  of  engineering  and  architectural  fee  actually  used  in  the  indus- 
trial world.  While  greater  accuracy,  at  first  glance,  seems  available  by 
limiting  these  charges  to  the  items  actually  affected,  it  is  doubtful  whether 
such  is  actually  the  case.  If  the  reconstruction  were  real  rather  than  hy- 
pothetical, the  fee  would  have  to  be  paid  on  the  percentage  basis.  To 
estimate  on  any  other  basis,  therefore,  is  theoretical  and  the  burden  of 
proving  the  advantage  rests  upon  the  advocate  of  the  change. 


172  FAIR  VALUE 

tory  appraisal  on  the  reproduction-cost  theory  can  scarcely 
be  held  to  a  higher  degree  of  accuracy  than  industrial  valu- 
ation permits.  It  must  be  remembered,  too,  that  if  any  de- 
gree of  accuracy  is  to  be  claimed  for  the  appraisers'  estimate 
the  allowance  must  vary.  A  much  smaller  percentage  for 
engineering  and  superintendence  will  suffice  in  the  con- 
struction of  a  simple  plant  than  in  one  involving  feats  of 
engineering;  and  an  engineer  will  undertake  the  work  of  a 
large  plant  on  a  less  percentage  than  that  of  a  small  one 
because  the  total  figure  will  be  greater.  Piecemeal  construc- 
tion and  similar  conditions  must  be  considered,  too,  in  de- 
termining the  percentage  to  be  allowed,  and  it  may  be  haz- 
arded that,  all  things  considered,  the  determination  of  the 
engineering  allowance  may  prove  to  be  the  province  of  the 
engineer  rather  than  that  of  the  economist. 

VI.  Contractors'  Profits 

The  question  of  contractors'  profits  has  created  more 
discussion  in  valuation  theories  than  allowance  for  promot- 
ers' profits.  The  problem  does  not  arise  in  the  original-cost 
appraisal,  for  such  profits  as  were  incurred  are  usually 
merged  with  the  property  items  and  entered  on  the  books. 
But  the  reproduction-cost  appraisal  opens  the  way  for  wa- 
tering accounts  through  this  channel.  The  appraiser,  as- 
suming that  if  the  plant  were  to  be  reconstructed  a  general 
contractor  would  be  employed  to  do  the  work,  creates  a  ba- 
sis for  application  of  a  contractors'profits  percentage  to  all 
items.  Such  a  hypothesis  may  be  excusable,  in  theory,  but 
here  as  elsewhere  the  reproduction-cost  appraisal  must  be 
restrained  by  the  sphere  it  occupies  in  valuation.  To  avoid 
the  charge  of  being  conjectural  within  the  prohibition  of 
the  Second  Minnesota  Rate  Cases,  the  allowance  must  be 
limited  by  the  facts  of  the  case.  Contractors'  profits  can  be 
allowed  where  they  were  an  expense  justifiably  incurred, 
i.e.,  where  the  utility  had  reason  to  believe  that  it  would 
be  more  economical  for  it  to  let  the  work  out  to  a  contrac- 


VALUATION  OF  INTANGIBLE  PROPERTY    173 

tor  than  to  undertake  it  itself  and  where  it  actually  did  let 
it  out.1  The  general  policy  of  the  commissions  has  been  to 
exclude  such  expenditures  as  a  separate  item.2  It  is  not  al- 
ways necessary,  customary,  or  advisable  for  a  utility  com- 
pany to  employ  a  general  contractor  for  its  construction 
work.  And  it  is  seldom  expedient  for  the  company  to  re- 
tain such  a  contractor  throughout  the  entire  construction 
period.  It  is  customary  to  construct  additions  and  better- 
ments and  make  purchases,  after  construction  is  well  under 
way,  by  dealing  directly  with  the  sub-contractors  and  elim- 
inating the  general  contractor's  profit.  Clearly,  therefore, 
no  general  contractor's  profit  allowance  can  be  properly 
included  in  the  valuation  in  the  absence  of  direct  evidence 
that  such  expenditures  were  incurred  and  reasonably  in- 
curred. 

When  an  allowance  for  contractors'  profits  is  made,  it 
must  be  based  upon  a  theoretical  value  reduced  from 
normal  by  the  savings  which  have  made  the  employment 
of  the  contractor  justifiable.  Such  an  allowance  cannot 
properly  be  made  where  the  value  approximates  the  ac- 
tual construction  cost  of  the  plant  created  without  the 
aid  of  the  contractor,  and  therefore  without  the  assumed 
economy. 

VII.  Discount  on  Bonds 

When  a  public-service  company  is  organized,  it  is  com- 
monly necessary  to  secure  funds  in  addition  to  those  de- 
rived from  the  sale  of  stock.  This  is  done  by  bond  issues. 
And  the  securities  are  floated  with  the  aid  of  an  underwrit- 

1  Ocean  County  Gas  Co.  (N.J.)  P.U.R.  1915-B-601;  Washington  & 
M.  R.  Co.  (D.C.)  P.U.R.  1915-B-558;  etc. 

2  Lincoln  v.  Lincoln  Water  &  L.  Co.  (111.)  P.U.R.  1917-B-l;  Corona 
v.  Corona  Home  T.  &.  T.  Co.  (Cal.)  P.U.R.  1915-F-1014;  Herman  v. 
Newton  Gas  Co.  (N.Y.  1st  Dist.)  P.U.R.  1916-D-825;  Rept.  St.  Louis 
Public  Service  Comm.  on  Electric  Rates,  1911,  p.  45;  Metropolitan  St. 
Ry.  Reorganization,  3  P.S.C.  1st  Dist.  N.Y.  113;  Berlin  Electric  Light 
Company,  3  N.H.  P.S.C.  174;  etc. 


174  FAIR  VALUE 

ing  firm.  The  underwriters  guarantee  to  place  the  securities 
on  the  market  and  dispose  of  them  within  a  fixed  time  at  a 
stated  price  sufficiently  below  the  market  price  to  repay 
the  guarantors  for  their  work.  The  securities  as  actually 
disposed  of  in  such  cases  are  subject  to  a  joint  discount,  part 
brokerage,  part  deferred  interest. 

It  has  been  the  contention  of  the  utility  that  brokerage 
is  "the  expense  necessary  to  be  paid  a  reputable  broker  for 
making  a  full  and  complete  investigation  into  the  cost  and 
prospects  of  an  inviting  public-service  enterprise  and  a  rea- 
sonable compensation  for  inducing  his  clientage  to  invest 
in  well-secured  bonds  and  securities  of  such  corporation," 
and  therefore  that  it  is  a  necessary  expense  quite  similar 
to  engineering  and  superintendence  and  to  be  valued  on 
the  same  basis.  The  State  Public  Utility  Commissions  have 
as  a  rule  adopted  a  contrary  theory.1   Bond  discount, 

1  Public  Service  Comm.  ex  rel.  Seattle  v.  Seattle  Lighting  Co.  (Wash.) 
P.U.R.  1915-B-135;  Terminal  Taxicab  Co.  (D.C.)  P.U.R.  1915-B-546; 
Camara  de  Comercie  v.  Manila  Elec.  R.  &.  L.  Co.  (P.I.)  P.U.R.  1915-D- 
977;  Campbell  v.  Hood  River  Gas  &  E.  Co.  (Or.)  P.U.R.  1915-D-855; 
Blue  Hill  St.  R.  Co.  (Mass.)  P.U.R.  1915-E-370;  Lima  v.  Lima  T.  &.  T. 
Co.  (Ohio)  P.U.R.  1916-E-670;  Re  Dunham  (Mo.)  P.U.R.  1916-E-544; 
Re  Citizens'  Tel.  Co.  (Ind.)  P.U.R.  1919-B-352;  Re  Joplin  &  Pittsburgh 
Ry.  Co.  (Mo.)  P.U.R.  1919-B-366. 

"Bond  discount,  constituting  a  payment  for  the  use  of  money,  is  in 
the  nature  of  an  interest  payment;  that  is,  it  is  not  'a  proper  capital 
charge,  but  rather  an  adjustment  of  the  interest  rate  to  the  existing 
market  condition  and  chargeable  to  interest  account  and  not  capital. 
The  Commission  is  of  the  opinion  that  brokerage  and  bond  discount, 
are  matters  to  be  considered  in  connection  with,  and  to  be  reflected  in, 
the  rate  of  return  allowed;  that  such  costs  should  be  made  up  out  of  in- 
come by  the  creation  of  a  sinking  fund  or  reserve  sufficient  to  cover  the 
cost  during  the  life  of  the  bonds,  and  that  therefore  such  costs  should 
not  in  equity  be  considered  a  part  of  the  cost  of  reproduction  or  of  the 
'fair  value'  to  be  taken  as  a  base  for  the  fixing  of  rates."  Potomac  Elec. 
Power  Co.  (D.C.)  P.U.R.  1917-D-563;  Greensburg  v.  Westmoreland 
Water  Co.  (Pa.)  P.U.R.  1917-D-478;  Lincoln  v.  Lincoln  Water  &  Light 
Co.  (111.)  P.U.R.  1917-B-l;  Chicago,  North  Shore  &  Milwaukee  Electric 
R.  Co.  (111.)  I.P.U.C.  No.  6186;  Pine  Lawn  v.  West  St.  Louis  Water  & 
Light  Co.  (Mo.)  P.U.R.  1917-B-679;  City  Water  Co.  (Mo.)  P.U.R.  1917- 
B-624;  Lamar  v.  Intermountain  R.  L.  &.  P.  Co.  (Col.)  P.U.R.  1918-B-86; 
etc.  Re  Mississippi  River  &  Bonne  Terre  Ry.  Co.  (Mo.)  P.U.R.  1918-C- 


VALUATION  OF  INTANGIBLE  PROPERTY    175 

whether  brokerage,  deferred  interest,  or  discount,  is  an 
interest  charge. 

The  utility  is  ordinarily  permitted  to  issue  bonds  to  be 
sold  at  a  reasonable  discount,  the  amount  to  be  determined 
by  the  figure  which  in  the  company's  judgment  is  the  most 
advantageous  interest  rate  for  the  securities  under  the  con- 
ditions of  the  money  market  at  the  time.  The  utilities  are 
permitted  to  exercise  judgment  in  determining  what  rate  of 
interest  will  produce  the  most  beneficial  results  from  the 
financial  viewpoint  of  the  particular  company. 

If  the  companies  were  permitted  to  capitalize  bond  dis- 
counts the  valuation  would  be  a  mere  matter  of  convenience 
resting  entirely  with  the  utility  issuing  the  bonds,  for  the 
amount  of  discount  varies  with  the  interest  rate.  The  lower 
the  interest  rate,  the  greater  the  rate  of  discount.  A  bond 
bearing  a  low  interest  rate  and  sold  at  a  large  discount,  cre- 
ates a  greater  burden  upon  the  consumer  than  a  bond  sold 
at  par  with  a  higher  interest  rate.  If  the  amount  chargeable 
to  the  capital  account  by  means  of  bond  discounts  were  left 
entirely  in  the  hands  of  the  company,  regulation  would  be 
nullified.  Bond  discount  represents  no  proper  loss  or  sacri- 
fice which  can  be  assessed  against  the  consumers  by  way 
of  rates.  It  must  be  treated  as  interest,  but  the  commissions 
have  usually  taken  cognizance  of  such  necessary  expendi- 
tures in  determining  the  rate  of  return. 

VIII.  Piecemeal  Construction 

A  public-utility  plant  which  has  been  constructed  piece- 
meal throughout  a  long  period  of  time  by  way  of  extensions 
and  betterments  cannot  expect  an  allowance  for  engineer- 
ing, architecture,  supervision,  etc.,  equal  to  that  of  a  plant 
carefully  planned  and  built  as  a  whole.  It  is  contended  that 
such  piecemeal  construction  is  more  costly  than  it  would 

321.  In  Omaha  &  L.  R.  &.  L.  Co.  (Neb.)  P.U.R.  1915-B-416,  bond' dis- 
count was  held  a  proper  capital  allowance  in  a  valuation  for  purchase- 
and-sale  purposes. 


176  FAIR  VALUE 

be  if  the  plant  were  constructed  in  one  continuous  opera- 
tion. But  the  added  cost  is  in  the  physical  plant,  not  in  the 
overhead  items.  Extensions  and  betterments  are  usually 
planned  and  carried  out  by  the  regular  operating  force  of 
the  utility.  Outside  engineering,  supervision,  and  manage- 
ment is  not  required. 

The  original-cost  appraisal  includes  the  additional  cost 
of  piecemeal  construction  in  the  original  cost  of  the  equip- 
ment. It  excludes  hypothetical  allowances  for  increased 
overhead  items  by  basing  the  estimate  on  actual  figures. 
The  reproduction-cost  appraisal  must  allow  lower  overhead 
items  in  case  of  piecemeal  construction,  and  will  admit  or 
reject  the  increased  costs  of  the  physical  equipment  accord- 
ing as  the  estimate  is  based  on  present  or  original  construc- 
tion conditions.  The  final  valuation  must  approximate  ac- 
tual conditions  to  determine  investment. 

IX.  Adaptation  and  Solidification 

Among  the  multitude  of  hypothetical  value  evils  arising 
from  the  Pandora-Box  valuation  in  the  Minnesota  Rate 
Cases  was  the  question  of  adaptation  and  solidification. 
When  a  railroad  is  first  constructed  the  newly  made  excava- 
tions wash  and  slip,  the  ditches  fill  from  the  action  of  the 
elements,  and  the  embankments  gradually  settle.  The  track 
superstructure  requires  constant  attention.  Lining  and 
dressing  of  ballasted  and  unballasted  track  are  necessary. 
Waterways  become  clogged  and  must  be  opened.  Bridges 
settle  and  must  be  put  back  into  line.  Station  grounds  re- 
quire finishing  and  improvement.  Unused  material  scat- 
tered during  the  construction  period  must  be  collected  and 
stored  or  junked.  The  finishing  touches  must  be  put  on  the 
whole  equipment  and  the  property  placed  in  orderly  con- 
dition. Actual  value  results  from  this  work.  The  mainte- 
nance charges  are  materially  decreased,  wear  and  tear  less- 
ened, and  accidents  occur  less  frequently.  And  there  can 
be  no  question  but  that  the  work  is  necessary.  Mr.  Morgan, 


VALUATION  OF  INTANGIBLE  PROPERTY    177 

therefore,  included  an  allowance  of  twenty  per  cent  in  his 
appraisal  to  cover  these  items.  The  Commission  rejected 
the  allowance.1 

Adaptation,  solidification,  and  seasoning  are  operating 
expenses,  not  capital  charges.  They  involve  no  sacrifice  by 
the  investor.  They  represent  no  additional  investment  or 
capital  outlay  as  permanent  improvements  do.  They  are 
primarily  a  maintenance  charge;  their  permanent  benefit 
is  wholly  incidental.  They  differ  little  from  ordinary  repairs. 
They  must  be  paid  for  from  revenue  the  same  as  worn-out 
ties,  and  cannot  properly  be  given  a  place  as  capital  in  the 
valuation  of  the  property.2  To  allow  such  charges  to  be  cap- 
italized for  rate-making  would  force  the  public  to  pay  the 
sum  so  charged  as  operating  expenses,  then  pay  a  return 
upon  it  as  a  capital  charge,  and  finally  pay  the  principal 
again  by  way  of  allowance  for  depreciation.  Approval  of 
such  a  valuation  would  merely  legalize  one  method  of  wa- 
tering capital. 

X.  Going  Value 

Probably  the  greatest  contest  in  the  valuation  field  has 
centered  on  the  question  of  going  value.  The  utilities  in- 
variably contend  that  a  regulatory  valuation  must  include, 
in  addition  to  the  value  of  the  physical  property  which  is 
devoted  to  the  public  service,  a  sum  alleged  to  attach  itself 
automatically,  barnacle-like,  to  every  "going  concern." 

1  Ann.  Rep.  Minnesota  R.R.  &  Warehouse  Comm.  1908,  p.  40. 

2  No  specific  allowance  was  made  for  adaptation  and  solidification  in 
the  railroad  appraisals  of  Wisconsin,  Michigan,  Texas,  and  South  Dakota. 
Mercantile  Trust  Co.  v.  Texas  &  Pacific  Ry.  Co.,  51  Fed.  529.  People  ex 
rel.  New  York,  Ontario  &  W.  Ry.  Co.  v.  Shaw,  143  App.  Div.  N.Y.  811, 
128  N.Y.  Supp.  177;  San  Joaquin  v.  Stanislaus  County,  191  Fed.  875;  Re 
Metropolitan  St.  Ry.  Reorganization,  3  P.S.C.  (1st  Dist.  N.Y.)  113; 
Chicago  &  Northwestern  Ry.  Co.  v.  Smith,  210  Fed.  632;  Ann  Arbor  R. 
Co.  v.  Fellows,  236  Fed.  387.  Special  allowances  have  been  made  in 
Minnesota,  Washington,  Massachusetts,  and  Alabama  to  cover  solidifi- 
cation during  construction  period,  etc.  See  also  Re  Tonopah  &  Tidewater 
R.  Co.  (Cal.)  22  A.  T.  &  T.  Co.  Comm.  Leaflets  1064;  Re  Missouri  So. 
R.  Co.  (Mo.)  P.U.R.  1916-C-G07. 


178  FAIR  VALUE 

This  parasite  bases  its  leasehold  rights  on  the  assumption 
that  value  accrues  irrespective  of  the  purpose  of  the  valua- 
tion from  the  fact  that  the  utility  is  actively  engaged  in  con- 
ducting a  successful  undertaking;  that  it  has  connected  to 
its  mains  many  buildings  and  numerous  consumers  who 
are  purchasing  its  products;  that  it  possesses  an  organiza- 
tion and  equipment  developed  for  conducting  its  business 
in  an  efficient  manner;  that  it  not  only  has  the  capacity 
to  earn  but  is  actually  earning;  and  is  a  living  entity  rather 
than  a  mere  collection  of  physical  assets. 

The  claim  seems  to  have  had  its  origin  in  a  tax  case  de- 
cided by  Justice  Brewer  in  1894  1  at  the  time  he  was  strug- 
gling in  the  tentacles  of  the  condemnation  analogy;  and  to 
have  been  developed  in  the  ill-considered  purchase  case 
wherein  the  United  States  Circuit  Court  of  Appeals,  in  an 
outburst  of  generosity  premised  upon  ignorance  of  the  lower 
court's  holding,  made  a  double  allowance  for  going  value 2 
in  spite  of  the  fact  that  the  utility's  franchise  had  expired 
and  its  right  to  operate  as  a  going  concern  had  ceased. 

The  origin  of  the  going-value  dispute  is  thus  traceable 
to  purchase-and-sale  and  tax  cases.  Here  the  analogy  to 
condemnation  is  relatively  close.  Market  value  is  sought 
and  capitalized  earnings  may  be  considered  within  reason- 

1  Cleveland,  Cincinnati,  Chicago  &  St.  Louis  Ry.  Co.  v.  Backus,  154 
U.S.  439. 

2  National  Water  Works  Co.  v.  Kansas  City,  62  Fed.  853,  10  CCA. 
653,  27  L.R.A.  827,  27  U.S.  App.  165.  The  Court  found  that  "the  city, 
by  this  purchase,  steps  into  possession  of  a  waterworks  plant,  —  not 
merely  a  completed  system  for  bringing  water  to  the  city,  and  distribut- 
ing it  through  pipes  placed  in  the  streets,  but  a  system  already  earning  a 
large  income  by  virtue  of  having  secured  connections  between  the  pipes 
in  the  street  and  the  multitude  of  private  buildings.  It  steps  into  pos- 
session of  a  property  which  not  only  has  the  pledge  to  earn,  but  is  in  fact 
earning.  It  should  pay  therefor  not  merely  the  value  of  the  system  which 
might  be  made  to  earn,  but  that  of  a  system  which  does  earn."  On  this 
basis  the  valuation  was  increased  $286,000.  The  lower  court,  however, 
had  already  valued  the  property  as  a  going  concern  and  taken  into  con- 
sideration existing  connections,  etc.  See  statement  of  Appraisal  Com- 
missioner Moore,  vol.  38,  Transactions  Am.  Society  of  Civil  Engineers, 
p.  151. 


VALUATION  OF  INTANGIBLE  PROPERTY    179 

able  limits.  In  such  cases  the  State  Commissions  have  uni- 
versally held  that  going  value  shall  be  included  in  the  valu- 
ation, provided  it  actually  exists.1  But  the  going  value 
thus  allowed  in  purchase  and  condemnation  cases  is  dis- 
tinct from  good-will  and  from  franchise  value,  and  it  is  not 
always  allowed  as  a  separate  item.2 

Several  methods  of  determining  going  value  have  been 
suggested.  The  utility  representatives  have  suggested  nu- 
merous "rules  of  thumb"  as  measures  of  such  value,  i.e.,  a 
percentage  allowance  of  the  appraised  value  or  of  the  gross 
annual  income,  or  a  definite  sum  per  consumer  or  inhabi- 
tant of  the  territory  served.3  It  is  apparent  that  such  rules 
are  too  indefinite  and  conjectural  to  warrant  more  than 
passing  consideration.  There  is  no  direct  relation  between 
such  measures  and  a  definite  going  value.  They  beg  the 
question  by  assuming  that  going  value  must  exist,  when  as 
a  matter  of  fact  it  may  or  may  not  be  present  in  a  given  util- 
ity property.  Its  determination,  when  it  is  present,  must 
be  made  according  to  the  facts  of  the  particular  case  and 
cannot  be  based  on  rules  of  thumb. 

Confusion  has  been  introduced  into  the  dispute  by  the 
use  of  various  definitions  of  the  term  "going  value"  by  the 
lower  courts  and  commissions.  Four  definitions  have  been 
generally  used.  The  term  has  been  interpreted  as  the  mere 
attribute  of  a  utility  in  normal  operation  —  organized,  oper- 
ating, and  engaged  in  the  public  service.  It  has  been  defined 
as  the  difference  between  the  exchange  value  of  the  plant 
and  its  appraised  present  value.  Going  value  has  been  used 
as  synonymous  with  "good-will"  to  mean  the  probability 

1  Omaha  v.  Omaha  Water  Co.,  218  U.S.  180,  54  L.  ed.  991,  30  Sup.  Ct. 
615;  Gloucester  Water  Supply  Co.  v.  Gloucester,  179  Mass.  365,  60  N.E. 
977;  City  of  Holyoke  v.  Holyoke  Water  Power  Co.,  Ann.  Rep.  Mass. 
G.  &  E.  Light  Commissioners,  1903,  pp.  77-82;  Galena  Water  Co.  v. 
City  of  Galena,  74  Kan.  624,  87  Pac.  735. 

2  Kennebec  Water  Dist.  v.  City  of  Waterville,  97  Me.  185,  54  Atl.  6; 
Re  Monongahela  Water  Co.,  223  Pa.  St.  323;  etc. 

3  Such  arbitrary  rules  have  not  been  wholly  discarded  however.  See 
Re  Michigan  State  Tel.  Co.  (Mich.)  P.U.R.  1918-C-81,  etc. 


180  FAIR  VALUE 

of  customers  continuing  to  come  to  the  same  company  for 
service.  And  the  term  has  been  held  to  mean  the  net  unrec- 
ompensed  deficits  sustained  by  the  company  during  the 
development  stage  of  its  existence,  while  operating  at  a  loss. 
Whether  any  of  these  forms  of  intangible  value  are  present 
in  any  particular  utility,  and  represent  real  unimpaired  in- 
vestment which  can  be  included  in  the  rate  valuation,  is  a 
question  of  fact  rather  than  theory. 

XI.  Going-Concern  Value 

Going  value  of  the  first  type,  the  mere  attribute  of  nor- 
mal operation,  has  been  most  widely  discussed.1  It  is 
based  upon  expenditures  made  by  the  utility  to  secure  new 
business,  by  way  of  "free  demonstration,"  "commercial 
expense,"  etc.  Such  charges  can  be  included  in  an  original- 
cost  inventory  or  the  final  valuation  only  when  the  items 
of  expense  were  actually  incurred  and  were  met  from  the 
capital,  not  the  operating  account.  If  the  expenditures  were 
not  incurred  or  were  cared  for  as  operating  expenses,  no 
sacrifice  or  investment  has  been  made  and  such  charges 
cannot  be  included  in  the  valuation.  If  the  expenditures 
were  actually  made,  but  have  been  repaid  by  the  consum- 
ers, it  is  obviously  improper  to  capitalize  a  duplicate  charge 
against  future  consumers.  Whenever  operating  expenses 
are  included  in  the  capital  account  the  utility  reaps  a  triple 
harvest.  The  investment,  if  one  exists  at  all,  is  made  by 
the  consumer.  He  is  forced  to  pay  a  return  to  the  utility 
on  his  own  investment,  and  in  the  end  he  must  duplicate 
the  investment  by  depreciation  allowances.  In  addition, 
unless  operating  expenses  are  reduced  in  direct  proportion 
to  the  charge  to  capital,  the  consumers  are  compelled  con- 
tinually to  repeat  this  fictitious  capitalization  to  their  own 
everlasting  detriment. 

1  Going-concern  value  has  been  allowed  in  Arizona,  California,  Idaho, 
Indiana,  Kansas,  Maine,  Maryland,  Missouri,  Ohio,  Washington,  Wis- 
consin, and  by  the  lower  Federal  Courts. 


VALUATION  OF  INTANGIBLE  PROPERTY    181 

The  criticism  of  this  form  of  going  value  holds  true  in  the 
reproduction-cost  as  well  as  the  original-cost  appraisal. 
Any  allowance  for  such  expenditures  would  create  a  ficti- 
tious capital  charge  confusing  operating  expenses  and  capi- 
tal in  the  assumed  reproduction  process  just  as  it  was  in 
the  actual  development. 

XII.  Going  Value  and  Exchange  Differential 

Going  value  defined  as  exchange  differential l  may  have 
a  place  in  valuation  for  purchase-and-sale  cases,  provided 
the  excess  allowance  is  amortized  from  income  within  a 
reasonable  period,  or  in  valuation  for  condemnation  or  tax- 
ation; but  it  cannot  be  considered  in  a  rate-base  valuation. 
Capitalization  of  an  exchange  differential  merely  intro- 
duces the  "  vicious  circle  "  whenever  the  question  involved 
is  the  fixing  of  reasonable  rates.  Earnings  are  dependent 
upon  rates  and  if  the  excess  net  earnings  over  a  fair  return 
upon  a  fair  value  of  the  property  are  capitalized  as  going 
value,  the  rates  cannot  be  altered  without  destroying  value. 
The  argument  is  but  a  poorly  camouflaged  attempt  to  re- 
establish the  rejected  market  value  of  the  property  as  a  rate 
base.  Such  going  value  has  been  universally  denied  by  the 
regulatory  commissions.2 

Going  value  interpreted  to  mean  the  value  of  the  estab- 

1  Camara  de  Commercio  v.  Manila  Elec.  R.  &.  L.  Co.  (P.I.)  P.U.R. 
1915-D-977;  Am.  Water  Works  Ass'n  Proceedings,  1909,  pp.  184-279; 
Trans.  Am.  Society  of  Civil  Engineers,  vol.  73,  pp.  326,  354;  Valuation  of 
Peoria  (111.)  Water  Works  Co.  by  B.  &  C.  B.  Williams,  1910,  pp.  11-13; 
etc. 

2  The  argument  is  stated  in  the  Second  Minnesota  Rate  Cases,  230  U.S. 
352,  33  Sup.  Ct.  729,  in  a  discussion  of  apportionment  of  values  between 
interstate  and  intrastate  traffic,  thus:  "The  value  of  the  use,  as  measured 
by  return,  cannot  be  made  the  criterion  when  the  return  itself  is  in  ques- 
tion. If  the  return,  as  formerly  allowed,  be  taken  as  the  basis,  then  the 
validity  of  the  State's  reduction  would  have  to  be  tested  by  the  very  rates 
which  the  State  denounced  as  exorbitant.  And,  if  the  return  as  permitted 
ander  the  new  rates  be  taken,  then  the  State's  action  itself  reduces  the 
amount  of  value  upon  which  the  fairness  of  the  return  is  to  be  computed." 
Fuhrmann  v.  Cataract  P.  &  C.  Co.  3  N.Y.  P.S.C.  (2d  Dist.)  656. 


182  FAIR  VALUE 

lished  business  is  very  similar  to  going  value  based  upon 
the  exchange  differential.  It  is  argued  that  a  utility  com- 
pany which  has  established  a  successful  business  is  of  far 
greater  value  than  one  possessing  only  a  physical  plant 
without  satisfied  consumers  attached  to  its  distribution 
system.  The  income  derived  from  the  consumers  attached 
in  the  one  case  and  not  in  the  other  is  the  only  conceivable 
additional  value.  If  the  income  derived  were  not  sufficient 
to  pay  operating  expenses  due  to  unreasonable  rates,  poor 
location,  or  other  similar  cause,  the  mere  fact  that  the 
consumers  were  attached  and  willing  to  accept  service  at 
the  unremunerative  rate  would  add  no  value  to  the  equip- 
ment. The  value  of  the  established  business  is  directly  de- 
pendent upon  the  earnings  from  the  business,  is,  in  fact, 
synonymous  with  capitalized  net  income  or  prospective 
income.  The  interrelationship  between  rates  and  such  going 
value  necessarily  excludes  it  from  consideration  in  the  rate 
base. 

It  is  only  when  the  theory  and  purpose  of  valuation  are 
completely  lost  sight  of  that  going  value,  thus  considered, 
can  have  any  place  in  the  appraisal  for  rate-making  pur- 
poses. Such  value  adds  nothing  to  the  worth  of  the  service 
and  forms  no  part  of  its  cost. 

XIII.  "Good-Will" 

Going  value  based  on  "good- will"  has  been  repeatedly 
rejected  as  an  element  of  value  for  rate-making  purposes 
by  the  United  States  Supreme  Court.  In  the  Des  Moines 
Gas  Case,1  Justice  Day  held  that: 

The  element  of  "good-will,"  as  applied  to  the  ordinary  mer- 
chant or  manufacturer  dealing  with  the  public  generally,  is  not 
considered  in  estimating  the  "going  value"  of  complainant's 

1  Des  Moines  Gas  Co.  v.  Des  Moines,  238  U.S.  113,  59  L.  ed.  1244.  See 
also  Omaha  v.  Omaha  Water  Co.,  218  U.S.  180,  30  Sup.  Ct.  615;  Willcox 
v.  Consol.  Gas  Co.,  212  U.S.  17, 29  Sup.  Ct.  192,  53  L.  ed.  382;  and  Cedar 
Rapids  G.  L.  Co.  t.  City  of  Cedar  Rapids,  223  U.S.  665,  32  Sup.  Ct.  389. 


VALUATION  OF  INTANGIBLE  PROPERTY    183 

plant.  It  cannot  be  considered  in  a  public  utility  like  the  one  in 
question  in  this  case,  because  the  complainant  has  a  monopoly 
of  business  in  which  it  is  engaged  in  the  city  of  Des  Moines,  and 
those  who  desire  to  use  its  products  must  buy  it.  .  .  .  That  "good- 
will" in  the  sense  in  which  that  term  is  generally  used  as  indicat- 
ing that  element  of  value  which  inheres  in  the  fixed  and  favorable 
consideration  of  customers,  arising  from  an  established  and  well- 
known  and  well-conducted  business,  has  no  place  in  the  fixing  of 
valuation  for  the  purpose  of  rate-making  of  public-service  corpo- 
rations of  this  character,  was  established  in  Willcox  v.  Consoli- 
dated Gas  Company. 

Appraisers,  however,  persist  in  including  "good-will," 
or  its  equivalent,  in  the  inventories  they  submit  to  the  regu- 
latory bodies,  in  spite  of  its  unqualified  rejection  by  the  Su- 
preme Court.  Capitalization  of  consumers  connected  to 
the  mains,  of  the  population  served,  of  the  business  or- 
ganization developed,  etc.,  is  injected  into  the  appraisal 
in  one  form  or  another  irrespective  of  monopolistic  condi- 
tions. 

Good-will  going  value  is  claimed,  too,  for  efficiency  in 
management,  competency  in  supervision,  and  similar  econ- 
omies.1 Its  advocates  argue  that  exceptionally  competent 
supervision  of  the  undertaking  or  efficient  management  of 
the  business  produces  corresponding  financial  standing; 
while  incompetent  management  produces  poor  financial 
results.  They  would  require  the  consumers  practically  to 
guarantee  competent  supervision.  Such  a  stand  is  untena- 
ble. The  consumers  are  legally  entitled  to  efficient  and  ade- 
quate service  and  may  demand  as  their  right  that  they  be 
served  competently.  Public-utility  officials  are  paid  from 
current  operating  expenses  taken  from  the  consumers  by 
way  of  rates  and  it  must  be  assumed  that  their  services  are 
rewarded  in  proportion  to  the  competency  of  the  officials. 
Neither  excellent  nor  incompetent  management  can  affect 
capital  value  for  rate-making  purposes.  The  consumer's 

1  See  argument  of  Counsel  in  Spring  Valley  Water  Works  Co.  v.  San 
Francisco,  192  Fed.  137. 


184  FAIR  VALUE 

obligation  ends  on  payment  of  fair  charges  for  the  service. 
It  becomes  the  utility's  duty  to  conduct  its  business  in  a 
reasonably  competent  manner  when  it  accepts  the  con- 
sumer's payment.  Any  reward  for  exceptionally  competent 
supervision  or  efficient  management  must  be  provided  by 
manipulation  of  the  rate  of  return. 

There  is  little  real  argument  for  including  good-will  when 
the  purpose  of  valuation  is  kept  in  mind.  The  object  is  to 
determine  the  cost  of  service.  Good-will  adds  nothing  to  the 
service.  Under  non-regulated  competitive  conditions  good- 
will cannot  be  considered  as  a  cost  in  price-fixing  without 
transferring  it  with  the  sales  to  the  less  fortunate  competi- 
tor who  has  not  included  it  in  his  price.  So  long  as  the  owner 
continues  in  the  undertaking,  he  has  added  nothing  to  his 
capital  stock  or  to  the  value  of  the  service  he  renders  or 
goods  he  sells.  He  can  secure  a  return  on  good-will  value 
only  by  a  sale  of  his  plant  or  when  he  enjoys  a  monopoly. 
Regulation  exists  for  the  express  purpose  of  preventing 
the  latter  type  of  return. 

XIV.   The  Wisconsin  Rule 

Going  value  based  on  accrued  deficits  incurred  during 
the  development  stage  of  the  utility's  operation  has  received 
lengthy  consideration  by  many  of  the  courts  and  commis- 
sions. The  Wisconsin  Railroad  Commission  early  devel- 
oped a  method  of  computing  past  deficits  and  surpluses  and 
decided  that  actual  unrepaid  early  losses  should  be  capital- 
ized. 

Going  value  is  determined  under  the  Wisconsin  method 
by  offsetting  annually,  for  each  year  since  the  company's 
inception,  all  bona-fide  operating  expenses,  including  re- 
pairs, maintenance,  taxes,  and  depreciation  charges,  and 
all  return  on  the  investment,  against  the  year's  actual  gross 
earnings.  Operating  expenses  often  exceed  the  income,  or 
prove  insufficient  to  provide  a  reasonable  return  on  the  in- 
vestment and  accruing  depreciation,  during  the  early  years 


VALUATION  OF  INTANGIBLE  PROPERTY    185 

of  the  utility's  development.  Deficits  are  thus  created  which 
the  Wisconsin  theory  considers  as  costs  properly  capital- 
ized on  the  same  basis  as  engineering  expense,  legal  fees, 
and  similar  expenditures  made  during  the  construction 
period.  But  the  gross  annual  revenue  invariably  exceeds 
the  total  annual  operating  expenses  and  creates  an  annual 
surplus  above  the  fair  return  during  the  later  years  of  the 
company's  development,  unless  the  project  is  either  poorly 
conceived  or  badly  managed.  The  Wisconsin  rule  balances 
the  total  annual  surpluses  and  deficits  at  the  date  of  the 
valuation,  unless  an  undue  period  has  passed,  and  capital- 
izes any  excess  of  deficits  over  surplus.  The  rule,  however, 
works  only  in  the  utility's  favor,  an  excess  surplus  in  no 
way  diminishes  the  capital  account. 

The  Wisconsin  going- value  theory  seems  inherently  er- 
roneous because  it  necessarily  rewards  past  inefficiencies 
in  management,  organization,  and  plant  and  equipment. 
The  greater  and  more  numerous  the  errors  of  a  utility  have 
been  in  the  past,  the  greater  computed  going  value  the 
utility  will  receive  under  this  theory.  Engineering  blunders 
in  the  monopolistic  utility  field  may  be  productive  of  an 
unreasonable,  or  an  exceptionally  large  and  remunerative, 
going  value  if  this  theory  is  strictly  adhered  to.  Poor  loca- 
tion becomes  as  advantageous  as  a  well-adapted  site,  save 
for  later  operating  expenses;  and  any  field  may  be  entered 
with  immunity  by  the  utility  irrespective  of  its  present 
ability  to  support  the  undertaking  at  reasonable  rates.  Such 
a  valuation  theory  cannot  be  accepted  for  rate-making 
unless  the  Commission  is  willing  to  disregard  the  public 
trust,  imposed  upon  it  by  law,  of  keeping  rates  within  the 
worth  of  the  service. 

Numerous  modifications  of  the  Wisconsin  rule  have  been 
developed  by  variance  in  the  method  of  disposing  of  esti- 
mated depreciation.  Appraisers,  in  computing  a  past-defi- 
cit going  value,  seldom  give  the  same  consideration  to  de- 
preciation in  the  capital  account  that  they  do  to  that  same 


186  FAIR  VALUE 

item  in  the  annual  operating-expense  account.  These  tac- 
tics produce  most  misleading  results.  When  appraisals  thus 
drafted  are  gone  over  and  depreciation  consistently  treated 
all  the  way  through,  the  going-value  allowance  is  very  fre- 
quently changed  from  a  net  deficit  to  a  net  surplus. 

The  past-deficit  method  of  determining  going  value  per- 
mits of  two  treatments  of  depreciation  in  its  relation  to 
such  value:  (1)  the  capital  account  may  be  reduced  by  an 
amount  identical  to  that  charged  against  annual  deprecia- 
tion, and  extensions  and  betterments  added  progressively 
to  capital;  or  (2)  the  original  capital  charge  may  be  pre- 
served and  going  value  made  sufficiently  comprehensive 
to  include  the  depreciation  fund  and  its  earnings  accumu- 
lated through  the  medium  of  annual  charges. 

Looseness  and  inaccuracy  are  drawn  into  the  allowance 
for  past  deficits  by  the  almost  universal  failure  to  consider 
the  accumulation  of  materials  and  supplies,  working  capi- 
tal, cash  surplus,  etc.,  during  the  years  of  operation.  Such 
accumulations,  if  they  had  been  declared  as  dividends, 
would  have  greatly  reduced  the  deficits  in  the  past.  Their 
neglect,  in  a  past-deficit  appraisal,  operates  to  pad  the  cap- 
ital account. 

XV.  The  Comparative-Plant  Estimate  of  Going  Value 

Closely  allied  to  the  valuation  of  past  deficits  is  the 
method  of  estimating  going  value  as  the  cost  of  repro- 
duction of  a  predetermined  income.  This  method,  predi- 
cated upon  the  assumption  that  going  value  necessarily 
exists  in  every  public-service  plant,  is  purely  hypothetical 
and  conjectural;  and  is  subject  to  innumerable  assump- 
tions which  make  it  capable  of  leading  to  any  results  the 
appraiser  may  wish  to  reach. 

The  comparative-plant  method  differs  from  the  Wiscon- 
sin system  only  by  a  slight  variance  in  the  basic  assump- 
tions. The  reproduction  method  assumes  that  a  new  com- 
pany, the  exact  counterpart  of  the  existing  utility,  begins 


VALUATION  OF  INTANGIBLE  PROPERTY    187 

operation  on  the  date  of  the  valuation,  and  that  the  exist- 
ing plant  ceases  to  exist,  though  the  environments  for  util- 
ity service  remain  unchanged.  An  arbitrary  period  is  as- 
sumed within  which  surplus  will  overtake  early  deficits  in 
the  operation  of  the  imaginary  corporation.  The  appraiser 
then  makes  a  guess  as  to  the  amount  which  the  utility 
would  spend  in  developing  the  business  during  that  period. 
The  estimate  has  no  foundation  in  fact.  It  is  a  mere  guess, 
worthless  as  a  check  upon,  or  supplement  to,  the  original- 
cost  inventory,  and  wholly  useless  in  the  endeavor  to  de- 
termine unimpaired  investment. 

Commissioner  Niles  considers  such  going  value  at  length 
in  Re  Grafton  County  Electric  Light  and  Power  Com- 
pany,1 thus: 

The  conditions  which  would  exist  if  the  prosperous  communi- 
ties of  Lebanon,  White  River,  and  Hanover  were  suddenly  de- 
prived of  electricity  . . .  are  unthinkable.  No  such  thing  has  ever 
happened.  And  yet  engineers  do  not  hesitate  to  testify  as  to  just 
how  long  it  would  take  these  same  people,  if  it  did  happen,  and 
the  plant  were  reconstructed,  to  make  up  their  minds  that  elec- 
tricity would  be  a  good  thing  for  them,  and  by  intricate  calcula- 
tions to  show  the  exact  amount  which  the  company  would  lose 
during  the  time  required  to  "educate"  the  intelligent  citizens  of 
these  towns  up  to  that  point  of  appreciation  of  the  value  of  elec- 
tricity to  which  they  have  already  attained.  And  this  it  is  claimed 
must  be  allowed  as  "going  value." 

Of  course,  the  fact  is  that  while  the  theory  of  cost  of  reproduc- 
tion rests  upon  the  assumption  of  present  conditions  in  every  re- 
spect except  for  the  non-existence  of  the  plant  to  be  reproduced, 
when  it  comes  to  estimating  going  value  on  the  basis  of  deficit 
from  operation  in  early  years  the  engineers  turn  their  backs  on 
their  own  fundamental  hypothesis,  and  assume  that  the  inhabi- 
tants of  these  towns  are  as  completely  ignorant  of  the  use  of  elec- 
tricity as  they  were  twenty  or  twenty -five  years  ago,  when  it  was 
first  introduced  to  them. 

There  is  another  absurdity  in  the  reproduction  theory  which  is 
suggested  by  the  consideration  of  the  developmental  period.  It  is 
assumed  that  the  plant  is  to  be  reconstructed  complete  as  at  the 

1  (N.H.)  P.U.R.  1916-E-887. 


188  FAIR  VALUE 

present  day,  with  every  extension,  not  merely  to  the  premises,  but 
into  the  very  houses,  including  the  actual  installation  of  meters, 
for  people  who  are  not  going  to  use  the  electricity  for  a  period  of 
three  or  four  years  after  the  construction  is  completed.  Such  a 
thing  has  never  been  done,  and  never  would  be  done  by  sane  men. 

The  courts  and  commissions  have  attached  no  weight 
to  the  hypothetical  theories  and  conjectures  of  the  expo- 
nents of  the  reproduction  or  comparative-plant  method  of 
estimating  going  value. 

XVI.  Going  Value  and  the  Courts 

There  has  been  great  uncertainty  in  the  Commission 
decisions  as  to  what  constitutes  going  value.  The  courts 
have  helped  little  to  clear  the  problem.  No  definite,  exact 
definition  of  the  term  has  been  attempted.  A  careful  con- 
sideration of  the  cases  indicates  that  any  element  of  value 
which  must  base  its  claim  for  consideration  on  the  increased 
worth  of  the  property  by  reason  of  a  well-organized,  fully 
developed,  paying  business,  rather  than  upon  actual  unre- 
paid  expenditures  made  during  the  development  stage  of 
the  undertaking,  must  be  excluded  from  the  rate-making 
valuation.  Expenditures  actually  made  during  the  devel- 
opment stage  of  the  business,  reasonably  necessary  and 
never  repaid  as  operating  expenses  or  excessive  return  (if 
such  are  conceivable),  might  be  allowed  as  going  value; 
though  the  courts  have  never  stated  the  necessity  of  such 
an  allowance.  No  separate  allowance  for  going  value  is 
necessary,  and  the  general  practice  of  the  State  Commis- 
sions is  to  make  none.  The  property  must,  however,  be 
valued  as  a  going  concern.  This  sounds  ambiguous,  but  it 
is  not. 

Property  of  a  public  utility  in  place  but  not  in  use  would 
have  only  scrap  value  —  less  than  junk  value.  The  difficul- 
ties connected  with  its  reclamation  would,  in  places,  wholly 
offset  its  value.  Such  valuation  of  the  property  would  be 
manifestly  unjust  for  any  purpose  even  after  the  expira- 


VALUATION  OF  INTANGIBLE  PROPERTY    189 

tion  of  the  franchise.  Such  a  valuation  for  rate-making 
purposes  would  clearly  violate  the  due-process  clause  of 
the  Fourteenth  Amendment.  To  prevent  this  inequity  the 
courts  have  held  that  the  property  must  be  valued  as  a  go- 
ing concern.  That  holding  implies  no  necessity  for  a  separate 
allowance  for  going  value.  No  separate  allowance  would 
be  possible  unless  premised  on  and  added  to  scrap  value 
rather  than  present  value. 

The  appraiser  instinctively  includes  such  going  value 
in  his  estimate  and  considers  the  plant  as  a  living  concern. 
If  this  were  not  true,  the  only  value  the  appraisal  would 
show  would  be  the  scrap  or  junk  value  of  the  physical  plant. 
Such  an  appraisal  could  make  no  allowance  for  intangible 
values.  An  appraisal  placing  a  fair  present  value  on  the 
items  inventoried  precludes  the  assumption  that  the  ap- 
praiser acted  upon  any  other  basis  than  the  consideration 
of  the  plant  as  a  going  concern. 

Any  element  of  going  value,  other  than  this  general  at- 
tribute which  prevents  an  inequitable  dwarfing  of  invest- 
ment, must  be  proven  by  the  utility  raising  the  claim.  The 
burden  of  substantiating  estimated  development  losses 
under  the  title  of  going  value  rests  upon  the  utility. 1  Such 
losses  to  merit  consideration  must  have  accrued  during 
the  development  or  experimental  stage,  must  have  been 
the  result  of  reasonable  expenditures  by  a  competent 
management  in  a  properly  located  undertaking,  and  their 
proof  must  be  accompanied  by  evidence  rebutting  the  pre- 
sumption that  subsequent  profits  have  repaid  the  early 
losses.  Losses  due  to  speculation  cannot  receive  considera- 
tion. 2 

1  Pillsbury  v.  Peoples  Gas  Light  Co.,  4  N.H.  P.U.C.  391;  Des  Moines 
Gas  Co.  v.  Des  Moines,  238  U.S.  113,  59  L.  ed.  1244;  etc. 

2  The  recent  decision  of  the  Federal  Supreme  Court  in  Denver  v. 
Denver  Union  Water  Co.,  62  L.  ed.  305,  March  4,  1918,  while  it  sustains 
a  separate  allowance  by  the  master  for  going  value,  does  so  on  the  facts 
of  the  particular  case  and  adds  nothing  to  the  holding  in  the  Des  Moines 
Case.  The  master's  allowance  was  based  on  the  compulsory  operation  of 


190  FAIR  VALUE 

XVII.  Franchise  Value 

Considerable  confusion  was  drawn  into  the  early  valua- 
tion discussions  by  a  belief  that  a  substantial  allowance 
must  be  made,  even  in  rate  cases,  for  franchise  values.  The 
theory  seems  to  have  had  its  origin  in  the  pestiferous  con- 
demnation analogy,  and  to  have  been  strengthened  by 
the  confusion  arising  from  the  attempt  to  base  rates  on 
exchange  value,  and  by  the  fact  that  franchise  values  had 
been  taxed.1  Numerous  theories  involving  a  conjectural, 
fictitious  allowance  were  advanced,  but  few  received  con- 
sideration. Franchise  values  are  admissible  in  tax,  purchase- 
and-sale,2  and  condemnation  cases,3  and  under  certain 
conditions  in  rate  cases.  They  are,  however,  necessarily 
excluded  in  the  great  majority  of  rate  valuations.  The  ques- 
tion can  be  properly  approached  only  by  starting  with  a 
consideration  of  the  true  nature  of  the  franchise. 

The  purpose  of  the  franchise  is  to  transfer  to  individuals 
the  Government's  right  to  conduct  what  has  been  denomi- 
nated a  public  undertaking.  The  special  privilege  of  exer- 
cising part  of  the  State's  sovereign  powers,  namely,  the 
right  to  use  the  public  highways  in  a  manner  imposing  an 
additional  burden,  and  the  right  to  condemn  private  prop- 
erty, are  transferred  by  the  franchise  to  the  individuals 
to  place  them  in  a  position  approximating  that  of  the  State. 
The  franchise  does  not  increase  the  value  of  the  property 
to  which  it  applies.  On  the  contrary,  it  limits  that  value 

the  utility  at  a  loss  under  highly  unsatisfactory  franchise  conditions.  The 
decision  guards  particularly  against  a  duplication  of  value  by  the  over- 
lapping of  going  value  and  franchise  value.  The  decision  contains  no 
mandate  that  going  value  must  be  included  as  a  separate  item,  provided 
the  property  is  valued  on  the  going-concern  basis. 

1  Spring  Valley  Water  Co.  v.  San  Francisco,  165  Fed.  667,  696;  St. 
Louis,  etc.,  R.R.  Co.  v.  Hadley,  168  Fed.  317;  etc. 

2  The  State  Commissions,  without  exception,  hold  that  franchise  value 
may  be  considered  in  purchase-and-sale  cases,  because  the  exchange 
value  of  the  plant  is  in  question. 

3  Monongahela  Navigation  Co.  v.  United  States,  148  U.S.  312,  13 
Sup.  Ct.  622,  37  L.  ed.  463.  The  cases  are  unanimous  in  allowing  fran- 
chise value  in  condemnation  proceedings. 


VALUATION  OF  INTANGIBLE  PROPERTY    191 

by  imposing  restrictions  and  burdens  upon  the  property 
and  decreasing  the  bundle  of  rights  which  compose  it.  The 
value  of  the  franchise  to  the  utility  lies  in  the  fact  that  it 
enables  the  company  to  go  ahead  and  engage  in  the  under- 
taking. It  changes  the  plant  from  an  inactive  to  a  live  or- 
ganization. The  value  thus  conferred  is  allowed  in  rate- 
making  by  appraising  the  property  as  a  going  concern.  It 
cannot  be  allowed  a  second  time  under  any  alias,  however 
attractive  it  may  sound. 

It  cannot  be  denied  that  the  franchise  has  value.  The 
State  recognizes  and  taxes  such  value.  But  it  does  not  nec- 
essarily follow  that  the  utility  possessing  the  franchise  is 
entitled  to  earn  a  return  upon  this  value.  No  reasonable 
interpretation  of  the  franchise  can  read  into  it  more  than 
a  contract  to  permit  the  utility  to  earn  a  return  on  its  in- 
vestment in  a  certain  way.  The  franchise  does  not  increase 
the  investment.  It  adds  no  producing  power  to  the  property. 
It  forms  no  part  of  the  elements  which  make  up  cost  of 
service,  save  in  so  far  as  it  represents  actual  capital  in- 
vestment. It  can  have  no  existence  as  an  element  of  value 
apart  from  the  physical  property  of  the  utility. 

The  public-utility  franchise  has  no  counterpart  in  the 
industrial  plant.  The  manufacturing  business  may  begin 
operation  at  will.  If  it  acquires  a  monopoly,  it  subjects  it- 
self to  control,  but  necessitates  no  franchise  grant.  Any  ad- 
ditional worth  of  service  developing  from  the  franchise, 
therefore,  must  be  based  upon  the  public  nature  of  the  un- 
dertaking, the  waiving  of  the  public  right  to  conduct  it; 
and,  therefore,  except  in  so  far  as  the  consideration  actu- 
ally paid  for  the  privilege  is  concerned,  is  a  sacrifice  or  in- 
vestment by  the  public,  not  the  stockholders,  upon  which 
the  public  alone  is  entitled  to  a  return. 

The  present  attitude  of  the  State  Commissions  toward 
franchise  value  is  fairly  stated  by  the  Wisconsin  Railroad 
Commission  in  Appleton  v.  Appleton  Water  Works  Com- 
pany,1 thus: 

1  5  W.R.C.R.  215,  281. 


199  FAIR  VALUE 

The  contention  often  made  that  the  value  of  franchises  should 
be  included  as  an  element  for  consideration  in  determining  the  pres- 
ent fair  value  of  the  active  property  of  a  public  service  corporation 
for  rate-making  purposes,  though  supported  by  judicial  sanction 
in  certain  jurisdictions,  does  not  appeal  to  us  as  either  sound  or 
practical.  The  only  measure  of  franchise  values  recognized  by  the 
courts  is  the  earning  capacity  of  the  property  to  which  the  fran- 
chises give  vitality.  Earnings  are  dependent  upon  the  rates  that 
are  exacted,  and,  hence,  the  higher  the  rates  the  more  valuable 
are  the  franchises,  and  vice  versa.  Obviously,  therefore,  it  would 
be  futile  to  attempt  to  determine  the  reasonableness  of  a  rate  by 
any  standard  which  is  at  all  dependent  upon  franchise  values  for 
its  dimensions.  Such  a  method  of  establishing  rates  would  only 
lead  to  conjecture  and  result  in  no  reliable  or  satisfactory  conclu- 
sion. .  .  .  The  concession  that  a  franchise  has  value  and  is  the  sub- 
ject of  property  rights  does  not  at  all  militate  against  the  principle 
that  a  franchise  is  not  capable  of  capitalization  for  the  purpose 
of  exacting  of  the  public  charges  in  excess  of  what  would  be  re- 
quired to  pay  a  reasonable  return  upon  the  actual  reasonable  in- 
vestment. To  permit  the  grantee  to  capitalize  the  franchise  as 
against  the  grantor,  would  be  similar  in  effect  to  adding  to  the 
consideration  for  service  an  additional  sum  based  upon  the  value 
of  the  contract  to  the  party  rendering  the  service. 

Franchise  value  in  rate  cases  can  be  allowed  only  in  ex- 
ceptional cases.  The  great  majority  of  the  public-utility 
franchises  in  the  United  States  have  been  acquired  without 
cost  to  the  stockholders  of  the  companies.  They  represent 
no  sacrifice  or  investment  upon  which  a  return  is  necessary. 
They  form  no  element  of  production  cost.  Such  value  as 
they  have,  not  forming  a  cost  element,  is  not  within  the 
scope  of  the  due-process  limitation  upon  rate-making. 
Where  the  State,  however,  has  specifically  and  expressly 
fixed  the  value  of  the  franchise,  and  estopped  itself  by  the 
representation  thus  made  to,  and  acted  upon  by,  the  util- 
ity, the  State  cannot  destroy  the  value  it  has  thus  created 
by  estoppel.1  The  State  has  in  effect  agreed  to  recognize 
franchise  value  to  a  definite  extent  as  a  cost  element.  The 
obligation  of  that  agreement  cannot  be  impaired. 

1  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  47,  29  Sup.  Ct.  192,  53  L. 
ed.  382. 


VALUATION  OF  INTANGIBLE  PROPERTY    193 

Where  the  public  utility  has  made  a  reasonable  bona-fide 
expenditure  to  secure  the  franchise,  the  sum  so  invested 
in  the  undertaking  may  be  capitalized.  There  is,  however, 
no  definite  holding  by  a  court  of  last  resort  that  such  sum 
must  be  included  in  the  valuation.  The  only  case  in  which 
its  inclusion  would  seem  mandatory  would  be  where  the 
expenditure  added  to  the  worth  of  the  service,  namely, 
where  it  was  reasonably  necessary,  used  or  useful,  and 
formed  a  part  of  the  justifiable,  as  opposed  to  the  actual, 
cost  of  the  service.  The  State  Commissions,  almost  with- 
out exception,  include  funds  expended  in  good  faith 
in  securing  franchise  privileges;  with  the  qualification, 
however,  that  the  franchise  so  secured  is  used  and  reason- 
ably necessary  in  rendering  the  service  in  question.1 

In  tax  cases,  in  purchase-and-sale  cases,  and  in  condem- 
nation proceedings  the  franchise,  in  so  far  as  the  valuation 
is  not  limited  as  hereinbefore  explained  by  the  rate-base 
value,  is  valued  at  its  market  value  based  upon  duration, 
earnings,  and  similar  considerations.  There  has  been  some 
dispute  in  the  past  concerning  the  method  of  determining 
the  market  value  of  the  franchise,  but  the  weight  of  opin- 
ion now  seems  to  favor  the  capitalization  of  earnings  based 
on  a  reasonable  rate  for  the  service  performed. 

XVIII.  Working  Capital 

The  appraisal  of  the  tangible  and  intangible  elements 
thus  far  considered  does  not  complete  the  valuation.  A 
utility,  to  conduct  its  business,  must  have  a  sum  for  mate- 
rial and  supplies  and  other  working  capital  in  addition  to 
that  invested  in  land,  buildings,  plant,  and  equipment.  The 
amount  necessary  to  meet  such  requirements  varies  with 
the  working  conditions.  Coal,  oil,  coke,  ties,  poles,  wire, 
material  for  renewals  and  replacements,  etc.,  must  be  car- 
ried in  stock.  A  reasonable  average  sum  to  cover  the  justi- 

>  Petaluma  &  S.  R.R.  Co.  (Cal.)  P.U.R.  1915-C-742;  Corona  v.  Corona 
Home  T.  &.  T.  Co.  (Cal.)  P.U.R.  1915-F-1014;  etc. 


194  FAIR  VALUE 

fiable  investment  in  such  supplies  is  a  proper  capital  charge 
and  should  be  considered  in  the  rate-making  valuation; 
providing  the  property  valued  constitutes  an  operating 
plant.1  Material  and  supplies  carried  for  new  construction, 
however,  cannot  be  separately  valued  if  they  have  received 
consideration  as  interest  during  construction  in  the  allow- 
ance for  overhead.2 

The  company  must,  in  addition  to  the  purchase  of  sup- 
plies, pay  its  employees  and  distribute  its  product  in  ad- 
vance of  the  receipts  from  rates.  The  bills  may  not  be  col- 
lected for  thirty  or  sixty  days.  The  amount  of  floating 
capital  necessary  to  meet  current  obligations  is  not  sus- 
ceptible of  certain  ascertainment.  The  prevailing  practice 
is  to  include  in  the  valuation  a  sum  sufficient,  in  the  judg- 
ment of  the  commission,  under  normal  conditions  to  meet 
and  carry  the  obligations  incurred  in  bills  payable  prior 
to  receipt  of  the  return  from  bills  receivable. 

XIX.  Summary 

In  valuation  of  the  intangible  elements  in  the  utility  prop- 
erty for  rate-making  purposes  the  aim  is  to  ascertain  the 
actual,  reasonable,  unimpaired  investment;  irrespective  of 
whether  circumstances  dictate  that  the  original-cost,  re- 
production-cost, or  normal-cost  theory  of  appraisal  be  given 
the  greater  weight.  Here,  more  than  anywhere  else  in  valu- 
ation, the  importance  of  the  unimpaired-investment  basis 
of  rate-making  is  apparent.  Unless  such  a  base  is  adopted, 
the  allowance  for  intangibles  becomes  a  mere  conjectural 
sum  predicated  upon  a  guess  unlimited  save  by  the  modesty 
or  lack  of  imagination  of  the  appraiser.  All  semblance  of 
true  relationship  to  cost  of  production  is  wiped  out. 

Estimates  of  intangible  values  must  be  inaccurate  at  the 

1  Working  capital  cannot  be  allowed  in  the  case  of  a  non-operating 
company.  Petaluma  &  S.  R.R.  Co.  (Cal.)  P.U.R.  1915-C-742. 

2  Mayhew  v.  Kings  County  Lighting  Company,  2  P.S.C.  (1st  Dist. 
N.Y.)  659. 


VALUATION  OF  INTANGIBLE  PROPERTY    195 

best.  An  appraisal  which  opens  the  door  to  unnecessary 
inaccuracy,  by  basing  estimates  upon  conjecture  and  hypo- 
thetical premises  when  facts  are  available,  cannot  be  too 
severely  condemned. 

Actual  bona-fide  expenditures  for  reasonable  organiza- 
tion expenses,  engineering  and  superintendence  fees,  in- 
terest on  a  reasonable  sum  idle  during  an  equitable  part 
of  the  construction  period,  insurance,  during  the  construc- 
tion period,  and  actual  expenditures  for  franchise  privileges 
have  been  universally  included  in  the  valuation.  Discount 
on  bonds  is  by  the  weight  of  opinion  considered  a  form 
of  interest  and  excluded  from  the  valuation.  Contractors' 
profits  and  promoters'  profits  are  included  when  shown 
to  have  been  actually  paid,  and  to  have  materially  bene- 
fited the  service.  Value  arising  from  adaptation  and  sol- 
idification has  been  regarded  with  suspicion,  but  included 
when  shown  really  to  constitute  a  used  and  useful  element 
in  the  production  of  the  service.  Good-will  value  is  flatly 
repudiated  and  going  value  has  been  widely  rejected  as 
a  separate  item,  but  the  property  has  been  universally 
valued  as  a  going  concern. 


CHAPTER  VIII 
DEPRECIATION 

I.  The  Theory  of  Depreciation 

The  original-cost  appraisal,  the  reproduction-cost  esti- 
mate, and  the  normal-cost  figures  show  the  actual  in- 
vestment in  the  utility  property.  The  valuation  decides 
which  of  these  careful  guesses,  in  view  of  the  facts  of  the 
particular  case,  approximates  most  closely  the  actual, 
bona-fide,  reasonable  investment  made  by  the  stockholders 
in  property  used  and  useful  in  rendering  the  public  service. 
This  figure  represents  the  justifiable  sacrifice  made  by  the 
investors,  and  the  value  of  the  property  fair  to  consumers 
and  stockholders  alike.  It  does  not,  however,  state  the 
"present  fair  value."  It  does  not  show  the  value  of  the 
property  assured  a  return  by  the  due-process  clause  be- 
cause actually  used  in  rendering  the  public  service. 

Valuation  is  resorted  to  only  in  the  case  of  plants  long 
in  operation.  The  value  of  such  systems  is  never  the  origi- 
nal investment  to  date.  It  is  rather  the  present  unimpaired 
investment.  The  moment  the  plant  is  put  in  place  and  op- 
erations begin,  wear  and  tear  starts  which  immediately 
diminishes  the  value,  and  sooner  or  later  renders  the  equip- 
ment useless.  Every  capital  item  in  the  public-utility  inven- 
tory, with  the  possible  exception  of  land,  is  a  more  or  less 
perishable  asset.  Buildings,  plant,  fixtures,  machinery, 
leases,  patents  and  contract  rights  which  are  limited  in 
duration,  distribution  systems,  rails  and  rolling  stock,  all 
are  the  prey  of  depreciation,  even  though  their  use  may 
have  been  slight.  Their  value  is  lessened  by  age,  natural 
decay  and  the  action  of  the  elements,  by  wear  and  tear  in 
use,  by  obsolescence  or  inadequacy,  by  accident,  and  by 
other  similar  forces.  This  unavoidable  loss  is  called  "de- 
preciation." 


DEPRECIATION  197 

Depreciation  may  be  defined  here  as  the  unavoidable 
decrease  in  the  value  of  a  perishable  asset  below  its  cost; 
occurring  during  the  period  of  its  use,  on  account  of  the 
action  of  the  forces  set  forth  above.  The  early  cases  made 
a  confusing  distinction  between  two  general  classes  of  de- 
preciation, physical  and  functional.  Physical  depreciation 
results  from  use,  or  from  the  exposure  of  the  assets  to  the 
elements.  Functional  depreciation  is  the  result  of  progress 
necessitating  more  efficient  appliances  or  larger  capacities 
for  successful  operation.  There  is  little  difference  between 
the  two.  Both  represent  a  loss  in  value  due  to  the  lessened 
life  of  the  equipment.  The  differentiation  is  predicated 
solely  on  the  nature  of  the  agency  shortening  the  life. 

The  theory  of  regulation  is  that  the  utility  is  entitled 
to  earn  a  fair  return  upon  its  reasonable  investment  and 
keep  that  investment  unimpaired.  Depreciation  seriously 
impairs  the  investment,  and  loss  from  this  source  is  irresist- 
ible. This  loss  in  value  of  the  equipment  is  clearly  a  part 
of  the  cost  of  service. *  Service  is  the  element  taken,  and  the 
payment  for  that  element  required  by  the  due-process 
clause  is  dependent  upon  the  cost  of  service.  The  rate  to 
be  reasonable  must  include  every  element  of  cost.  Accruing 
depreciation  is  undeniably  such  an  element.  The  utility, 
therefore,  is  entitled  to  secure  from  rates  a  sum,  in  addition 
to  operating  expenses  and  return  upon  the  justifiable  in- 
vestment, which  will  enable  it  to  offset  this  loss  as  it 
accrues.  Both  the  stockholders  and  the  public  suffer  if  the 
utility  management  is  remiss  in  its  obligation  to  collect  a 
fund  for  replacements,  or  if  the  fund  collected  is  not  used 
to  counteract  the  wasting  of  assets. 

Depreciation  has  occurred  in  the  case  of  every  operating 
utility  valued.  If  the  depreciation  reserve  has  been  collected 

1  Nicholson,  Cost  Accounting,  Theory  and  Practice,  pp.  26, 27;  Cole,  Cost 
Accounting  for  Institutions,  p.  46;  Ridgway,  Cost  Accounts,  p.  39;  Scovell, 
Cost  Accounting  and  Burden  Application,  p.  80;  Moxey,  Principles  of  Fac- 
tor Cost  Keeping,  p.  75;  etc. 


198  FAIR  VALUE 

and  is  intact,  or  has  been  properly  used  in  making  replace- 
ments, the  capital  is  unimpaired.  If  the  fund  has  not  been 
used  to  counteract  depreciation,  but  has  been  paid  out  in 
dividends,  on  the  theory  that  it  represented  profit,  a  part 
of  the  investment  has  been  withdrawn,  is  not  used  in  ren- 
dering the  service,  and  is  not  within  the  protection  of  the 
due-process  clause.  The  net  profit  available  from  earnings 
cannot  be  determined  before  every  element  of  cost  of  serv- 
ice is  charged  against  the  gross  profit.  Depreciation  is  a 
cost  element.  It  is  immaterial  whether  regulation  required 
the  maintenance  of  a  depreciation  reserve.  The  element  of 
manufacturing  cost  could  not  be  changed  by  taking  advan- 
tage of  a  loophole  in  the  law  to  pay  dividends  from  capital. 
Depreciation  occurred.  The  value  of  the  equipment  was 
decreased.  The  company  was  obligated  to  make  good  that 
decrease  or  charge  a  corresponding  amount  to  the  capital 
account.  The  situation  differs  in  no  manner  from  that  in 
which  the  company  sells  outright  a  portion  of  its  equip- 
ment and  pays  out  the  proceeds  as  dividends.  Accrued 
depreciation  unprovided  for  lessens  the  value  of  the  operat- 
ing plant  and  is  equivalent  to  a  withdrawal  to  that  extent 
of  capital  originally  invested. 

It  is  apparent  that  depreciation  presents  two  distinct 
problems  in  valuation  work.  The  appraised  value  of  the 
property,  representing  the  cost  new,  must  be  diminished 
to  show  the  losses  which  have  already  occurred  from  physi- 
cal or  functional  depreciation.  And  provision  must  be 
made  to  meet  the  losses  which  are  to  occur  in  the  future 
from  those  causes,  so  that  the  present  unimpaired  invest- 
ment may  be  maintained  in  statu  quo. 

II.  Efficiency  and  Depreciation 

The  loss  by  wear,  obsolescence,  or  accident  decreases 
the  value  of  the  plant  materially  and  continuously.  It  may 
be  a  long  time  after  operation  starts  before  repairs  or  actual 
replacements  become  necessary,  but  the  loss  in  value  is 


DEPRECIATION  199 

going  on  all  the  time.  It  may  not  greatly  lessen  the  effi- 
ciency of  the  equipment  or  the  quality  of  the  service  ren- 
dered, but,  thanks  to  the  utility  invocation  of  the  due- 
process  clause,  neither  efficiency  nor  quality  of  service  is 
the  object  sought.  Neither  is  the  basis  of  fair  value.1 
Failure  to  keep  this  point  in  mind  caused  much  confusion 
in  the  early  valuations.  Skillful  manipulation  of  the  am- 
biguous word  "efficiency,"  as  a  middle  term  in  argument 
leading  to  the  fallacious  conclusion  that  depreciation  does 
not  exist  in  the  ordinary  plant  when  maintenance  is  not 
slighted,  caused  the  misconception.  A  similar  use  of  the 
ambiguous  middle  term  "profit"  furthered  the  deception. 
Utility  appraisals  drew  a  word  picture  portraying  depre- 
ciation as  a  sort  of  Jekyll  and  Hyde  entity,  non-existent  so 
far  as  reduction  of  value  to  meet  past  loss  is  concerned,  but 
looming  genii-large  when  future  loss  is  considered. 

The  utilities  sought  to  establish  a  distinct  line  between 
accrued  and  accruing  depreciation.  The  significance  of 
their  action  is  apparent.  The  loss  in  efficiency  in  a  plant 
does  not  occur  with  the  same  rapidity  as  the  loss  in  value 
resulting  from  depreciation.  The  plant  may  be  maintained 
at  practically  one  hundred  per  cent  efficiency,  by  apt  main- 
tenance and  repairs,  and  still  suffer  an  accrued  depreciation 
of  twenty  or  more  per  cent.  After  comparatively  short 
operation  the  plant  reaches  what  has  been  called  a  state  of 

1  The  State  Commissions  have  repeatedly  held  that  the  fact  that  the 
plant  is  operated  at  one  hundred  per  cent  efficiency  does  not  entitle  the 
company  to  a  plant  value  of  one  hundred  per  cent  of  condition  new  in  a 
valuation  for  rate-making  purposes.  See  Salinas  City  v.  Coast  Valleys 
Gas  &  El.  Co.  (Cal.)  P.U.E.  1915-B-460;  Re  Janesville  Water  Co.  (Wis.) 
P.U.R.  1915-A-178;  Lincoln  v.  Lincoln  L.  &  W.  Co.  (111.)  P.U.R.  1917- 
B-l;  etc.  But  see,  Butler  v.  Lewiston  A.  &  W.  St.  R.R.  Co.  (Me.)  P.U.R. 
1916-D-25;  Rich  v.  Biddeford  &  S.  W.  Co.  (Me.)  P.U.R.  1917-C-982, 
1000;  and  Chesapeake  &  P.  T.  Co.  (Md.)  P.U.R.  1916-C-925,  holding 
that  the  fact  that  the  property  has  been  kept  up  to  a  high  level  of  effi- 
ciency should  be  considered  in  ascertaining  its  depreciation.  These  de- 
cisions seem  to  confuse  efficiency  and  depreciation  and  attempt  to  make 
an  allowance  by  way  of  depreciation  which  would  ordinarily  be  cared  for 
in  fixing  the  rate  of  return. 


200  FAIR  VALUE 

"average  depreciation."  The  depreciation  remains  almost 
stationary  at  from  twenty  to  thirty  per  cent  of  the  cost  new. 
The  efficiency  is  maintained  at  approximately  one  hundred 
per  cent.  The  argument  made  by  the  utilities  has  been  that 
past  depreciation  should  be  figured  on  the  basis  of  effi- 
ciency irrespective  of  the  life  of  the  equipment,  but  that 
accruing  depreciation  should  be  figured  on  the  basis  of  the 
probable  additional  life.  Thus,  in  the  case  of  a  plant  op- 
erating at  practically  one  hundred  per  cent  efficiency  there 
would  be  no  reduction  in  value  due  to  past  loss  by  wear 
and  tear.  Any  surplus  collected  by  way  of  depreciation 
reserve  would  be  available  for  dividends.  No  depreciation 
having  occurred,  according  to  this  argument,  the  entire 
capital  charge  of  the  equipment  would  have  to  be  spread 
over  the  admittedly  shortened  life  of  the  equipment  in  order 
to  provide  for  its  retirement  at  the  end  of  that  life.  This 
would  increase  the  percentage  of  the  depreciation  allowance 
and  leave  a  handsome  net  profit  for  the  manipulator. 

The  no-past-depreciation  view,  perhaps  honestly  enter- 
tained, was  prevalent  in  early  valuation  cases.  Many  of  the 
engineers  employed  in  valuation  work  considered  any 
reduction  for  accrued  depreciation  an  attempt  to  regulate 
past  profits,  in  the  nature  of  a  confiscation  of  property, 
depriving  the  investor  of  the  return  on  that  part  of  his 
investment  deducted.  The  late  Henry  Floy,  in  his  work  on 
"Valuation  of  Public  Utilities,"  takes  the  stand  that  no 
depreciation  should  be  deducted  from  cost  new,  except 
perhaps  an  insignificant  sum  necessary  to  keep  the  plant 
in  a  one  hundred  per  cent  operating  condition.  Mr.  Hum- 
phrey, in  a  paper  on  "Estimated  and  Actual  Depre- 
ciation," read  before  the  American  Gas  Institute,1  took 
the  same  stand.  Mr.  James  Allison,  in  a  report  to  the 
St.  Louis  Public  Service  Commission,2  concocts  a  novel 

1  Proceedings  of  American  Gas  Institute,  vol.  8,  part  n,  page  521. 

2  Should  Public  Service  Properties  Be  Depreciated,  Sept.  11,  1912.  Pro- 
fessor Allyn  Young,  in  an  article  on  "Depreciation  and  Rate  Control," 


DEPRECIATION  201 

theory  wherein  he  eliminates  depreciation  by  valuing  the 
plant  at  a  "normal"  depreciated  value  and  including  the 
loss  due  to  depreciation  in  the  going  value  as  a  cost  of 
establishing  the  business. 

Variation  of  depreciation  methods  to  meet  the  conditions 
in  the  individual  plant  is  desirable  in  the  case  of  industrials, 
but  the  public-utility  accounting  requirements  are  differ- 
ent. Those  elements  of  public  interest  which  distinguish 
the  utility  from  other  industries  necessitate  stricter  ac- 
counting methods.  Regularity  and  uniformity  of  accounts 
are  absolutely  necessary  to  successful  regulation.  Some  of 
the  State  Commissions  have  sought  to  apply  different  de- 
preciation methods  to  different  utilities,  but  the  general 
attitude  of  the  regulatory  bodies  is  that  one  system  must 
be  rigidly  applied  to  all.  The  attempt  by  utility  advocates 
to  establish  one  rate  for  accrued  and  another  for  accruing 
depreciation  has  strengthened  this  attitude.1 

reprinted  from  the  Quarterly  Journal  of  Economics  for  August,  1914,  took 
a  somewhat  similar  stand  holding  that  to  deduct  accrued  depreciation 
from  the  rate  valuation  when  no  depreciation  fund  had  been  actually 
maintained,  would  merely  be  a  regulation  of  past  profits.  Such  arguments 
are  clearly  based  upon  a  misconception  of  profits  in  so  far  as  they  do  not 
rest  upon  a  confusion  of  efficiency  and  depreciation. 

1  The  Illinois  Public  Utilities  Commission  states  the  attitude  of  regu- 
latory bodies  in  general  in  its  Third  Annual  Report,  1916,  p.  120,  where 
it  says:  "Argument  for  the  adoption  of  the  sinking-fund  theory  of  treat- 
ing accrued  depreciation  would  be  far  more  convincing  were  an  adherence 
to  the  one  theory  consistently  practiced  to  the  exclusion  of  all  other 
theories.  In  submitting  the  question  of  current  or  accruing  depreciation, 
it  is  often  argued  that  the  same  percentages  which  have  been  used  for 
accrued  depreciation  computed  under  a  sinking  fund  should  be  increased 
somewhat  by  an  allowance  for  future  contingent  depreciation.  It  is  this 
lack  of  consistency  which  causes  a  doubt  to  arise  as  to  the  sincerity 
of  arguments  for  deduction  of  accrued  depreciation  by  other  than  the 
straight-line  method.  One  rate  for  depreciation  in  the  properties  for  the 
time  that  has  passed,  and  another  rate  for  the  time  that  is  to  come,  with 
the  date  of  a  rate-making  proceeding  as  the  dividing  line,  is  the  essence 
of  the  question  presented.  Obviously,  the  only  guide  to  the  future  is  what 
has  occurred  in  the  past.  .  .  .  Rate-regulatory  commissions,  more  and 
more,  are  insistent  that  the  subject  of  depreciation  be  presented  in  a  fair 
manner  under  all  circumstances  by  the  public  utilities  which  appear 
before  them;  and,  above  all,  the  commissions  are  requiring  that  utilities 


202  FAIR  VALUE 

All  of  these  theories  are  founded  upon  a  confusion  of  loss 
of  efficiency  and  depreciation.  Such  advocates  ask  that  the 
commissions  close  their  eyes  to  all  existing  depreciation  and 
assure  the  public  that  property  that  has  been  used  for  more 
than  half  its  useful  life  and  must  soon  be  replaced  is 
worth  the  cost  new.  The  argument  relies  too  much  upon 
the  credulity  of  the  public.  Thorough  maintenance,  unlim- 
ited repairs,  and  careful  usage  may  prolong  the  life  of  the 
equipment,  but  it  cannot  wholly  counteract  the  deteriora- 
tion. It  cannot  provide  for  the  discarding  of  equipment  to 
meet  unexpected  developments  in  the  industry,  in  the 
amount  of  business  or  the  type  of  machinery.  It  cannot 
prevent  accidental  loss  from  explosion,  fire,  storm,  etc.  It 
cannot  even  insure  efficiency  in  the  face  of  such  losses. 
Commissions  and  courts,  with  few  exceptions,  therefore, 
have  ruled  against  the  no-depreciation  theories. 

III.  Judicial  Holdings  on  Depreciation 

The  earlier  decisions  of  the  Federal  Supreme  Court  seem 

confused  on  the  question  of  depreciation.  In  Union  Pacific 

be  consistent  in  the  treatment  of  all  angles  of  the  subject."  Commissioner 
Max  Thelen  of  California  commented  similarly  on  this  point  in  the  Palo 
Alto  Gas  Case,  10  Rate  Research,  93,  saying:  "I  am  becoming  increas- 
ingly impressed  with  the  absolute  necessity  on  the  part  of  all  parties  of  a 
consistent  treatment  of  the  subject  of  depreciation  irrespective  of  the 
nature  of  the  particular  proceeding  which  is  being  considered  and  of  the 
interest  of  the  parties  therein.  The  Railroad  Commission  has  found  in  a 
number  of  instances  that  while  in  rate  cases  in  which  it  is  to  the  interest 
of  the  utility  to  secure  as  large  an  allowance  as  possible  for  depreciation 
annuity,  the  utility  has  eloquently  presented  the  need  for  a  large  depre- 
ciation reserve,  yet,  when  it  came  to  the  declaration  of  dividends  and  the 
placing  of  apparent  additional  value  on  common  stock,  the  utility  has 
insisted  that  its  property  depreciates  but  very  little  and  that  only  a 
small  depreciation  annuity  and  depreciation  reserve  are  necessary.  Like- 
wise, we  have  had  instances  in  which  the  same  utility  has  claimed  a  large 
depreciation  annuity  in  a  rate  case  and  later,  when  its  property  was  being 
condemned,  has  claimed  that  its  property  is  in  almost  100  per  cent  phys- 
ical condition  and  that  only  a  small  deduction  should  be  made  for  ac- 
crued depreciation.  It  is  unnecessary  to  point  out  that  a  utility  will  gain 
nothing  in  the  long  run  with  the^public  authorities  by  making  such  con- 
flicting claims." 


DEPRECIATION  203 

Railroad  v.  United  States1  the  language  of  the  decision  was 
broad  enough  to  include  depreciation  in  the  expenses  charge- 
able to  earnings  in  determining  net  profit.  But  in  United 
States  v.  Kansas  Pacific  Railway  Company,2  decided  the 
same  year,  no  deferred  renewals  or  replacements  were  al- 
lowed as  a  charge  against  profits.  The  more  recent  decisions, 
however,  regard  depreciation  as  a  proper  charge.  Thus,  in 
the  City  of  Knoxville  v.  Knoxville  Water  Company,3  the 
Court  said  in  part: 

A  water  plant,  with  all  its  additions,  begins  to  depreciate  in 
value  from  the  moment  of  its  use.  Before  coming  to  the  question 
of  profits  at  all,  the  company  is  entitled  to  earn  a  sufficient  sum 
annually  to  provide  not  only  for  current  repairs,  but  for  making 
good  the  depreciation  and  replacing  the  parts  of  the  property  when 
they  come  to  the  end  of  their  life.  The  company  is  not  bound  to  see 
its  property  gradually  waste,  without  making  provisions  out  of 
earnings  for  its  replacement.  It  is  entitled  to  see  that  from  earn- 
ings the  value  of  the  property  invested  is  kept  unimpaired.  ...  It 
is  not  only  the  right  of  the  company  to  make  such  a  provision,  but 
it  is  its  duty  to  its  bond  and  stockholders,  and,  in  the  case  of  a 
public-service  corporation  at  least,  its  plain  duty  to  the  public. . . . 
If,  however  a  company  fails  to  perform  this  plain  duty  and  to  ex- 
act sufficient  returns  to  keep  the  investment  unimpaired,  whether 
this  is  the  result  of  unwarranted  dividends  upon  over-issues  of 
securities,  or  of  omission  to  exact  proper  prices  for  the  output,  the 
fault  is  its  own.  When,  therefore,  a  public  regulation  of  its  prices 
comes  under  question,  the  true  value  of  the  property  then  em- 
ployed for  the  purpose  of  earning  a  return  cannot  be  enhanced 
by  a  consideration  of  the  errors  in  management  which  have  been 
committed  in  the  past. 

A  similar  ruling  is  made  in  the  Consolidated  Gas  Company 
Case.4  These  cases  were  not  clear  in  their  inclusion  of  func- 
tional depreciation,  but  this  point  was  cleared  by  its  allow- 
ance in  the  Des  Moines  Water  Company  Case.5 

1  99  U.S.  402,  25  L.  ed.  274  (1898).  *  99  U.S.  459. 

3  212  U.S.  1,  13,  29  Sup.  Ct.  149,  53  L.  ed.  382. 

4  "Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  29  Sup.  Ct.  192,  53  L. 
ed.  382.  See  also  Cumberland  T.  &.  T.  Co.  v.  Louisville,  187  Fed.  637,  654. 

5  Des  Moines  Water  Co.  v.  Des  Moines,  192  Fed.  193,  197;  affirmed, 
238  U.S.  153.  See  also  People  ex  rel.  Kings  Co.  L.  Co.  v.  Public  Service 
Comm.,  210  N.Y.  479. 


204  FAIR  VALUE 

The  weight  of  authority  in  commission  and  court  deci- 
sions now  requires  a  reasonable  deduction  from  cost  new 
for  accrued  depreciation  both  physical  and  functional,  and 
an  identical  treatment  in  the  case  of  accruing  depreciation. l 
The  amount  of  the  depreciation  and  the  method  of  ascer- 
taining it,  however,  have  not  been  fixed  by  the  Court, 
though  there  is  considerable  uniformity  as  to  method  in 
the  State  Commission  practice. 

Computations  of  depreciation  depend  upon  three  ele- 
ments, the  investment,  or  cost  less  salvage  value,  the  age, 
and  the  life  of  the  asset.  The  difficulties  involved  in  the 
depreciation  problem  are  those  of  the  determination  of  these 
three  elements.  The  problems  presented  are  those  of  the 
engineer.  Having  found  the  elements,  depreciation  becomes 
an  accounting  problem.  The  methods  of  ascertaining  the 
three  depreciation  elements  have  been  varied,  and  confusion 
has  been  introduced  by  confusing  the  engineering  and  ac- 
counting features. 

IV.  Salvage  Value 

The  first  issue  presented  by  the  depreciation  problem  is 
the  determination  of  the  cost  on  which  deterioration  is  to 
be  estimated.  As  an  accounting  problem  the  solution  is  sim- 
ple. When  a  renewal  is  made,  the  original  cost  of  the  equip- 
ment retired  is  removed  as  an  asset,  by  crediting  the  plant 
account,  and  the  cost  of  the  new  equipment  is  entered  by 
debiting  that  account.  The  cost  of  the  item  retired  is  re- 
covered by  crediting  the  depreciation  account,  and  the  cost 
of  the  new  equipment  becomes  a  charge  against  that  ac- 
count to  be  amortized  within  the  estimated  life  of  the  item. 

1  Accrued  depreciation  was  rejected  as  unjust  to  the  utility  by  the 
Idaho  Commission  in  Sandpoint  v.  Sandpoint  Water  &  L.  Co.  (Idaho) 
P.U.R.  1915-F-445;  and  Murray  v.  Public  Utilities  Comm.  (Idaho)  150 
Pacific  47,  P.U.R.  1915-F-436.  The  Massachusetts  Commission  refused 
to  deduct  for  accrued  depreciation  where  the  failure  to  provide  a  depre- 
ciation reserve  was  not  due  to  mismanagement  and  only  meager  dividends 
had  been  paid.  Blue  Hill  Street  R.  Co.  (Mass.)  P.U.R.  1915-E-370. 


DEPRECIATION  205 

The  original  cost  of  the  equipment  retired  included  the 
cost  of  installation.  The  retirement  cost  includes  the  simi- 
lar costs  involved  in  the  removal  of  the  equipment,  but  is 
decreased  by  any  value  of  the  item  as  scrap  or  second- 
hand equipment.  The  difference  between  the  scrap  value 
and  the  cost  of  removal  is  the  positive  or  negative  salvage 
value,  and  must  be  accounted  for  before  depreciation  is 
figured.  The  cost  which  must  be  amortized  is  the  original 
cost  of  the  equipment  increased  or  decreased,  as  the  case 
may  be,  by  the  salvage  value. 

The  original-cost  appraisal  treats  depreciation  just  as 
the  accountant  shows  it  on  the  books.  The  reproduction 
and  normal  cost  estimates,  however,  necessarily  base  depre- 
ciation on  the  estimated  reproduction  or  normal  cost  new 
plus  or  minus  the  estimated  salvage  value.  The  final  valua- 
tion is  dictated  by  the  appraisal  method  accepted  for  the 
particular  case. 

V.  Depreciation  of  Intangibles 

A  further  question  arises  as  to  the  sum  to  be  depreciated. 
Every  public-utility  inventory,  it  has  been  pointed  out,  lists 
numerous  items  representing  cost  of  intangibles  properly 
included  in  the  valuation.  The  problem  is,  Shall  these  values 
be  depreciated  as  the  tangible  items  of  plant  and  equipment 
are,  or  shall  they  be  treated  as  land  and  considered  free 
from  depreciation? 

Intangible  values  fall  naturally  into  two  classes.  Engi- 
neering, supervision,  and  similar  expenses  attach  to  tangi- 
ble items  and  really  form  a  part  of  the  cost  of  those  items. 
When  the  tangible  property  wears  out  or  becomes  obsolete 
and  is  replaced  new,  overhead  outlays  are  necessarily  in- 
curred in  connection  with  the  replacement.  The  erection 
of  a  new  building  necessitates  architectural  fees.  The  in- 
stallation of  a  new  boiler  involves  engineering  expense. 
Such  overhead  costs  serve  no  useful  purpose  after  the  tan- 
gible assets  to  which  they  attach  have  been  replaced.  They, 


206  FAIR  VALUE 

therefore,  must  be  amortized  from  the  depreciation  reserve 
during  the  life  of  those  assets.1 

Other  intangible  costs  are  of  a  more  general  character 
and  cannot  be  considered  a  part  of  the  expense  of  any  sin- 
gle item  or  class  of  items  of  the  tangible  property.  They  are 
incurred  only  once  and  form  a  part  of  the  cost  of  the  com- 
posite plant.  Such  elements  of  value  are  affected  by  time 
only  when  the  life  of  the  whole  plant  is  limited.  Ordinarily, 
they  are  not  depreciated.2 

Overhead  costs  which  do  not  seem  to  fall  distinctly  into 
either  of  these  classes,  like  interest  during  construction,  and 
taxes  and  insurance  before  operation  is  started,  must  be  in- 
cluded in  the  first  class  and  be  amortized. 

When  depreciation  is  figured  as  an  arbitrary  percentage 
based  on  the  fair  value  of  the  plant  and  a  composite  life,  all 
overhead  items,  of  course,  must  be  depreciated. 

VI.  Estimated  Life 

The  difficult  problem  involved  in  determining  deprecia- 
tion is  the  fair  estimating  of  the  probable  life  of  the  prop- 
erty. The  wasting  assets  which  compose  a  public-utility 
plant  are  of  many  kinds.  The  estimated  life  of  each  class 
will  be  different.  The  estimated  life  of  each  item  in  the 
class  may  vary  on  account  of  working  conditions,  use,  etc. 
Local  conditions  affect  the  separate  items  and  the  composite 
life  of  the  plant.  The  type  of  construction,  the  manner  of  in- 
stallation, the  character  of  the  management,  and  the  policy 
as  to  maintenance  and  repairs  materially  affect  the  life  of 
the  equipment;  and  the  date  of  installation,  character  and 
adequacy  of  the  equipment  installed,  are  controlling  ele- 
ments, particularly  in  estimating  functional  depreciation. 
The  problem,  though  often  forced  upon  the  accountant,  is 

1  Portland  Railroad  L.  &.  P.  Co.  (Or.)  P.U.R.  1916-D-976;  Rates  of 
Missouri  Southern  R.R.  Co.  (Mo.)  P.U.R.  1916-C-607;  Campbell  v. 
Hood  River  G.  &.  E.  Co.  (Or.)  P.U.R.  1915-D-855;  Chicago  &  North 
Shore  Elec.  R.R.  Co.  (111.)  P.U.R.  1918-A-388. 

2  Lima  v.  Lima  T.  &.  T.  Co.  (Ohio)  P.U.R.  1916-E-670. 


DEPRECIATION  207 

an  engineering  one  involving  actual  inspection  as  well  as 
theoretical  treatment. 

VII.  The  Maintenance  Plan  and  Appraisal 

The  oldest  and  perhaps  the  simplest  attempt  to  meet  the 
depreciation  issue  was  the  maintenance  plan  whereby  the 
consumer  was  charged  for  all  repairs  and  renewals  of  the 
year.  The  system  was  extremely  faulty  in  that  during  the 
early  part  of  the  estimated  life  of  the  wasting  asset  practi- 
cally no  charge  was  made,  while  during  the  later  periods  of 
the  life,  the  asset  deteriorated  rapidly  and  excessive  pay- 
ments were  required.  The  system  further  failed  to  take  into 
consideration  the  fact  that  in  spite  of  maintenance  and 
repairs,  assets  must  eventually  be  retired  and  a  loss  of  capi- 
tal occur. 

Probably  the  depreciation  system  next  devised  was  that 
known  as  the  "appraisal  plan."  Under  this  system  the  ap- 
praiser inspected  the  property  and  estimated,  from  the  ex- 
amination, the  loss  due  to  accrued  depreciation.  The  plan 
was  subject  to  most  of  the  defects  of  the  maintenance  sys- 
tem, since  the  wear  and  tear  during  the  early  life  of  the 
equipment  does  not  necessarily  show  proportionately  to  the 
degree  in  which  it  has  actually  occurred. 

Neither  of  these  forms  of  handling  the  depreciation  prob- 
lem has  received  the  sanction  of  the  public-service  com- 
missions. 

VIII.  The  Straight-Line  Method 

Perhaps  the  most  universally  used  theory  of  determining 
depreciation  is  the  straight-line  method.  This  system,  when 
the  estimated  life  is  made  with  due  regard  to  all  known 
operating  conditions,  most  closely  approximates  the  facts 
surrounding  utility  operation  and  financing;  and  is  thor- 
oughly consistent,  both  in  the  capital  account  and  in  the 
annuities  to  be  set  aside  from  operating  expenses.  When 
this  method  of  estimating  depreciation  is  applied,  the  total 


208  FAIR  VALUE 

amount  to  be  written  off  as  impaired  investment  is  distrib- 
uted equally  between  the  periods  of  the  estimated  life  of 
the  property  valued,  by  dividing  the  balance  between  the 
cost  new  and  salvage  value  by  the  estimated  life. 

This  method  of  depreciation,  though  widely  enforced  by 
regulatory  bodies,  has  met  with  considerable  opposition 
from  the  utilities,  on  the  ground  that  it  does  not  spread  the 
burden  equitably  over  the  estimated  life  period.  The  plan 
assumes  that  the  property  depreciates  in  direct  proportion 
to  age,  though  it  is  common  experience  that  such  is  not  the 
case.  The  argument  extended  to  include  maintenance  is 
that  already  suggested,  that  immediately  following  the  ac- 
quisition of  the  property  there  is  little  or  no  expenditure 
required  for  maintenance  and  repairs,  but  in  the  later  pe- 
riods of  its  estimated  life  considerable  expense  is  necessary 
for  upkeep.  So  far  as  accounting  is  concerned,  the  argu- 
ment continues,  the  figure  which  must  be  evenly  spread 
over  the  life  of  the  property  is  the  sum  of  the  depreciation 
charge  plus  the  item  of  plant  maintenance  and  upkeep. 

This  criticism  is  scarcely  justified  by  practice.  In  a  plant 
which  has  been  operating  any  considerable  length  of  time 
the  cost  of  repairs  tends  to  reach  an  average  annual  sum. 
No  two  items  of  equipment  wear  with  exactly  the  same 
rapidity.  One  generator  will  receive  more  or  harder  usage 
than  another.  Additions  and  betterments  will  change  the 
rates.  The  result  is,  the  maintenance  expense  will  not  vary 
greatly.  Diversity  of  equipment,  therefore,  may  be  relied 
upon  to  apportion  maintenance  charges  with  comparative 
equality.  So  far  as  plant  value  is  concerned,  many  engineers 
contend  that  the  loss  is  greatest  at  the  start  and  gradually 
decreases  as  the  property  ages.  The  benefits  of  imposing 
heavy  depreciation  charges  at  the  start  to  offset  light  main- 
tenance expense  in  the  case  of  a  new  plant,  on  the  other 
hand,  are  somewhat  doubtful  inasmuch  as  the  income 
during  the  early  operating  periods  is  slight  and  the  in- 
creased burden  may  prove  a  real,  as  well  as  an  unnecessary, 
hardship. 


DEPRECIATION  209 

The  criticism  of  the  straight-line  method,  while  perhaps 
of  great  weight  to  the  accountant,  is  entitled  to  little  con- 
sideration from  the  regulatory  standpoint,  for  maintenance 
and  upkeep  are  operating  expenses  and  must  be  treated  in 
rate-making  as  wholly  distinct  from  the  depreciation  charge 
which,  though  a  cost  element,  is  in  the  nature  of  a  capital 
item  rather  than  an  expense.  The  criticism  so  far  as  depre- 
ciation is  concerned  seems  superficially  based  upon  the  con- 
fusion of  depreciation  and  efficiency.  The  consumers  of  the 
service  during  the  early  periods  of  the  plant's  life  benefit 
from  the  use  of  the  property  fully  as  much  as  the  consumers 
who  receive  service  during  the  later  periods.  The  theory  of 
regulation  is  that  the  consumers  during  each  period  ought 
to  bear  a  portion  of  the  total  depreciation  expense  relative 
to  the  service  they  receive  from  the  property  valued.  This 
division  of  cost  is  accomplished  by  the  straight- line  method. 

It  has,  moreover,  the  advantages  of  simplicity,  of  reason- 
able conformity  to  actual  conditions,  and  of  allowing  the 
funds  to  be  used  for  necessary  additions  and  thus  to  earn 
a  return  from  the  business  as  well  as  provide  better  service. 

IX.  The  Diminishing- Balance  Method 

The  criticism  of  the  straight- line  method,  however,  has 
not  been  entirely  ineffective.  A  system  of  estimating  de- 
preciation, known  as  the  "  diminishing-balance  method," 
was  originated  to  eliminate  the  objections  made  to  the 
straight-line  theory.  This  method  makes  annual  retirances 
approximate  annual  depreciation  as  closely  as  possible. 
The  depreciation  rate  under  such  a  system,  instead  of 
being  a  given  percentage  of  cost,  is  based  on  the  diminish- 
ing balance  of  cost  less  depreciation.  A  depreciation  per- 
centage is  applied  to  the  cost  new  and  the  result  deducted 
as  the  first  year's  allowance.  The  same  percentage  is  then 
applied  to  the  reduced  value  to  ascertain  the  second  year's 
allowance.  The  process  is  repeated  during  each  year  of  the 
estimated  life  until  only  the  salvage  value  remains  unamor- 


210  FAIR  VALUE 

tized.  The  percentage  under  this  system  must  be  greater 
than  under  the  straight-line  method  when  the  same  amount 
is  to  be  written  off  in  the  same  length  of  time,  for  the  value 
to  which  it  applies  is  constantly  decreasing. 

The  formula  of  the  diminishing-balance  method  is  ex- 
tremely complicated.  The  burden  of  the  depreciation  is 
shifted,  and  becomes  much  heavier  in  the  early  years  of  the 
estimated  life  of  the  property  than  in  the  later  period;  on 
the  theory  that  the  increased  burden  in  repairs  and  main- 
tenance in  the  later  few  periods  will  tend  to  make  the  total 
annual  burden  substantially  the  same.  The  advantages  de- 
rived from  this  method  are  theoretical  rather  than  practi- 
cal. It  does  not  conform  to  the  actual  operating  conditions 
in  the  utility  field.  It  does  not  spread  the  burden  accord- 
ing to  the  benefit  received.  And  it  could  be  successfully 
applied  to  accruing  depreciation  only  where  it  had  been 
honestly  carried  out  with  respect  to  accrued  depreciation. 
The  result  is  that  the  system  has  not  met  with  favor  from 
the  regulatory  commissions. 

X.   The  Annuity  Method 

Another  substitute  for  the  straight-line  system  of  esti- 
mating depreciation  is  known  as  the  "annuity  method." 
It  is  premised  upon  the  theory  that  the  cost  of  production 
should  include  not  only  maintenance,  repairs,  and  depre- 
ciation, but  also  the  interest  on  the  capital  invested  in  the 
asset.  This  method  has  been  universally  rejected  by  com- 
missions and  courts,  because  in  a  regulatory  programme 
interest  on  investment  is  considered  a  profit  to  be  cared 
for  by  the  rate  of  return  rather  than  an  element  of  cost  or 
a  capital  asset.  It  is  not  in  conformity  with  operating  con- 
ditions. The  method  is  artificial  and  it  writes  off  a  greater 
amount  during  the  later  years  of  the  property's  estimated 
life  than  during  the  first  years,  thus  maintaining  an  inflated 
value  during  the  early  periods  of  the  plant's  life  and  doub- 
ling the  burden  on  the  consumers  who  have  the  use  of  the 


DEPRECIATION  211 

depreciated  investment,  who  pay  an  equal  or  higher  op- 
erating expense,  and  who  should  not  pay  more  than  an  equal 
depreciation  charge. 

XI.   The  Sinking-Fund  Method 

The  sinking-fund  method  of  estimating  depreciation  has 
met  with  unaccountable  approval  from  the  utilities,  but 
with  corresponding  disapproval  on  the  part  of  courts  and 
commissions  generally.1  It  is  based  on  the  theory  that  the 
amounts  set  apart  for  depreciation  will  be  invested  at  com- 
pound interest  and  the  returns  thus  secured  added  to  the 
reserve.  The  amount  of  the  depreciation  reserve  necessa- 
rily taken  from  income  is  thus  decreased  by  the  amount 
of  the  accumulating  interest.  The  actual  provision  made 
for  depreciation  by  this  method  is  lowest  during  the  early 
years  of  the  estimated  life  of  the  property  and  increases 
gradually  till  the  retirement.  This  feature  has  material  ad- 
vantages. The  actual  wear  and  functional  deterioration  of 
the  property  follow  much  the  same  increasing  line  that  the 
reserve  does.  The  loss  in  efficiency  of  the  property  corre- 
sponds more  closely  to  this  plan;  and  the  earnings  from  the 
business  increase  with  years  in  a  similar  manner. 

Theoretically  the  sinking-fund  method  of  estimating  de- 
preciation possesses  many  advantages.  Practically  it  is  sel- 
dom applicable.  It  can  be  successfully  adopted  for  accruing 
depreciation  only  when  it  has  been  carefully  applied  to  ac- 
crued depreciation  and  the  fund  derived  therefrom  with  the 
accrued  interest  is  intact;2  or  when  the  actual  accrued  de- 

1  The  Wisconsin  and  District  of  Columbia  Commissions  have  recently 
developed  a  depreciation  method  midway  between  the  straight-line  and 
the  four  per  cent  sinking-fund  theories  which  has  received  favorable  con- 
sideration in  many  quarters.  Croty  v.  Tomah  Elec.  &  Tel.  Co.  (Wis.) 
P.U.R.  1917-A-439;  Potomac  Elec.  Power  Co.  (D.C.)  P.U.R.  1917-D- 
563. 

2  This  feature  of  the  struggle  to  impose  the  sinking-fund  method  upon 
the  commissions  is  clearly  dealt  with  by  the  Illinois  Public  Utility  Com- 
mission, thus:  "  Carrying  the  illustration  one  step  further,  and  introducing 
the  assumption  that  the  generator  was  purchased  and  installed  completely 


212  FAIR  VALUE 

preciation  is  computed  on  the  straight-line  method,  and 
the  sinking-fund  method  applied  to  the  balance.  It  creates 
a  non-usable  reserve  which  handicaps  maintenance  and 
repairs  and  makes  the  system  ill-adapted  to  actual  opera- 
tion with  its  multitude  of  contingencies  requiring  aid  from 
the  reserve  fund.  It  assumes  that  the  fund  will  find  ready 
investment  and  that  the  interest  it  will  draw  will  be  unvary- 
ing, though  experience  has  shown  that  such  is  not  the  case. 
It  withdraws  the  fund  from  the  business,  where  under  or- 
dinary conditions  it  would  earn  a  much  larger  return  than 
the  interest  it  draws.  The  most  that  can  be  said  for  the  sys- 
tem is  that,  under  advantageous  conditions,  it  is  suscep- 
tible of  a  high  degree  of  accuracy. 

XII.  Miscellaneous  Methods 

One  method  of  estimating  depreciation  is  based  upon  a 
periodic  revaluation  or  appraisal  of  the  property.  This  the- 
ory has  met  with  little  approval  because  of  its  cumber- 
someness  and  the  fact  that  it  does  not  apportion  the  bur- 
den between  the  consumers  of  the  different  periods  of  the 
estimated  life  of  the  property  on  any  rational  basis. 

at  a  total  cost  of  $10,000,  one  would  arrive  at  a  present  value  of  $5000 
by  the  straight-line  method  and  at  a  present  value  of  practically  $6000 
by  the  sinking-fund  method,  after  an  expiration  of  ten  years  of  the  20- 
year  life;  and,  under  these  conditions,  the  annuity  by  the  straight-line 
method  is  $500  and  by  the  sinking-fund  method  $336.  It  is  customary  for 
utilities,  although  they  have  in  no  manner  during  past  years  provided 
any  depreciation  reserve  (sinking-fund  or  otherwise),  to  ask  for  $6000 
in  present  value  and,  if  they  be  consistent,  $336  for  depreciation  annuity 
to  replace  the  generator  10  years  later.  Thus  the  utility,  by  its  sinking- 
fund  method,  assumes  the  burden  of  $4000  in  accrued  depreciation;  but 
claims  a  remaining  value  of  $6000,  which  it  is  purposed  to  equalize  by 
annual  payment  of  $336  for  the  next  ten  years.  A  short  computation  will 
indicate  that  ten  annual  payments,  when  compounded  with  interest  at 
five  per  cent  per  annum,  will  yield  a  total  of  $4200.  Obviously,  to  insti- 
tute and  follow  a  sinking-fund  theory  of  depreciation,  merely  because 
either  a  valuation  proceeding  or  a  rate  case  happens  to  be  in  progress,  a 
shortage  of  $1800  (or  18  per  cent)  in  this  particular  illustration  is  in- 
evitable. Similar  shortages,  in  varying  amounts,  would  occur  in  every 
item  of  utility  equipment  in  the  entire  plant."  Third  Annual  Report 
Illinois  Public  Utilities  Commission,  1916,  p.  118. 


DEPRECIATION  213 

Another  method  is  based  upon  the  number  of  hours  in 
which  the  property  is  actually  used  instead  of  the  estimated 
life  in  terms  of  years  or  months.  The  system  has  some  ad- 
vantages from  the  cost  accountant's  viewpoint,  but  has  no 
distinctive  features  so  far  as  regulation  is  concerned. 

There  are  multitudinous  other  vari-named  methods  of  es- 
timating depreciation  which  merit  no  specific  consideration. 

XIII.  The  Colorado  Theory  of  Depreciation 

The  Colorado  Public  Utilities  Commission  has  developed 
a  depreciation  theory  of  its  own.  Accruing  depreciation  is 
provided  for  in  the  same  manner  that  other  commissions 
handle  the  question.  In  the  case  of  accrued  depreciation, 
Colorado  recognizes  both  the  "straight-line"  and  "sink- 
ing-fund" methods.  Both  are  considered  fundamentally 
correct,  and  fair  to  the  consumer  and  the  utility  alike,  when 
properly  applied.  The  Commission  proceeds  upon  the  the- 
ory that  in  determining  the  fair  value  of  the  property  of  a 
public  utility  for  rate-making  purposes  no  deduction  should 
be  made  for  accrued  depreciation  on  the  ground  that  the 
property  is  old,  obsolete,  inadequate,  or  otherwise  incapa- 
ble of  giving  good  service.  The  exclusion  from  the  inven- 
tory of  physical  property  not  used  or  useful,  or  not  in  rea- 
sonably good  service  condition  and  necessary  to  the  opera- 
tion of  the  property,  is  held  to  counteract  sufficiently  all 
loss  in  value  arising  from  wear  and  tear,  obsolescence,  and 
inadequacy.  Where  accrued  depreciation  has  been  allowed, 
the  Commission  has  based  the  deduction  on  the  amount 
in,  or  which  should  have  been  in,  the  depreciation  reserve; 
and  made  a  decrease  for  the  purpose  of  giving  the  consum- 
ers the  benefit  of  the  earnings  from  the  fund.  The  Com- 
mission states  its  theory  in  the  case  of  Lamar  v.  the  Inter- 
mountain  Railway,  Light  and  Power  Company,1  thus: 

It  seems  to  the  Commission  to  be  self-evident  that  if  the  interest 
earnings  on  the  amounts  set  aside  annually  for  depreciation  are 

1  P.U.R.  1918-13-98,  100. 


214  FAIR  VALUE 

to  be  credited  to  the  depreciation  reserve,  the  investor  in  the  prop- 
erty of  the  public  utility  should  receive  a  fair  return  upon  the 
investment  in  the  property  during  its  useful  life,  regardless  of  its 
physical  condition;  or,  in  other  words,  if  the  annual  depreciation 
requirement  is  estimated  and  set  aside  on  the  sinking-fund  basis, 
a  deduction  on  account  of  depreciation  cannot  properly  be  made 
in  arriving  at  the  amount  upon  which  the  investors  in  that  prop- 
erty are  entitled  to  earn  a  fair  return. 

Conversely,  it  is  true  that  if  the  annual  depreciation  require- 
ment is  to  be  set  aside  on  the  straight-line  basis  —  that  is,  if  a 
sum  is  to  be  set  aside  annually  which,  without  interest  accruals, 
will  replace  the  depreciable  property  at  the  end  of  its  life,  and,  in 
addition,  the  consumer  is  required  to  pay  a  fair  return  on  the  in- 
vestment in  the  property  throughout  its  useful  life  —  the  con- 
sumer will  have  paid  to  the  utility  a  sum  which  will  be  in  excess 
of  a  fair  return  by  the  combined  earnings  of  the  depreciation  re- 
serve. Since,  therefore,  when  the  sinking-fund  method  of  providing 
for  depreciation  is  followed,  no  deduction  on  account  of  deprecia- 
tion may  fairly  be  made,  it  follows  that,  if  the  reserve  is  set  aside 
on  the  straight-line  basis,  a  sum  equal  to  the  amount  in  the  depre- 
ciation reserve,  or  such  an  amount  as  the  reserve  might  reasona- 
bly have  been,  had  it  not  been  disbursed  in  the  form  of  dividends, 
should  be  deducted  in  arriving  at  the  fair  value  of  the  property 
for  rate-making  purposes,  otherwise  the  consumer  would  be  re- 
quired to  pay  somewhat  higher  rates  under  the  straight-line  than 
under  the  sinking-fund  method. 

Conceding,  therefore,  that  fundamentally  deduction  on  ac- 
count of  depreciation  should  be  made  for  the  reason  that  the 
consumer  is  entitled  to  such  amounts  as  can  be  earned  by  the  un- 
expended balance  in  the  depreciation  reserve,  it  follows  that  de- 
duction for  depreciation  should  be  made  to  give  the  consumer  the  benefit 
of  such  earnings,  rather  than  on  the  theory  that  an  old  property  is  not 
as  valuable  for  rate-making  purposes  as  a  new  one.  Also,  since  by 
the  very^nature  of  a  sinking-fund  reserve  the  consumer  is  auto- 
matically given  the  benefit  of  the  earnings  of  the  unexpended  bal- 
ance in  the  depreciation  reserve,  it  follows  that  no  deduction  on 
account  of  depreciation  may  be  made  when  the  sinking-fund 
method  is  employed. 

The  Colorado  treatment  of  depreciation  may  be  justified, 
but  not  upon  the  theory  advanced.  Such  a  concept  of  ac- 
crued depreciation  cannot  be  reconciled  with  the  cost-of- 
production  basis  of   valuation.   Accrued   depreciation   is 


DEPRECIATION  215 

deducted  from  cost  new  to  secure  the  rate  base  because  the 
investment  has  been  impaired  to  the  extent  that  deprecia- 
tion has  occurred  and  no  method  of  treating  depreciation 
can  alter  this  fact.  The  capital  is  no  longer  employed  in 
the  public  service  and,  therefore,  cannot  earn  a  return.  The 
funds  in  the  depreciation  reserve,  however,  may  be  em- 
ployed in  a  manner  that  justifies  the  commissions  in  adding 
them  to  the  (depreciated)  value  of  the  plant  for  purposes 
of  rate  regulation.  When  the  reserve  which  should  have 
been  held  against  accrued  depreciation  has  been  paid  out 
in  dividends,  it  is  not  the  loss  of  the  interest  on  the  fund 
which  affects  the  public.  There  has  been  an  actual  with- 
drawal of  investment.  The  property  is  no  longer  within  the 
protection  of  the  due-process  clause.  To  hold  otherwise  is 
deliberately  to  ignore  facts  and  seek  justification  by  confu- 
sion of  efficiency  and  depreciation. 

When  depreciation  has  been  counted  on  the  straight- 
line  method  and  the  assets  invested  in  the  securities  of 
other  companies,  the  capital  is  unimpaired,  but  the  de- 
preciation funds  should  not  be  included  in  the  valuation 
for  rate-making  purposes.  The  assets  invested  in  outside 
securities  are  not  used  or  useful  in  rendering  the  public 
service,  and  therefore  have  no  part  in  determining  the 
reasonable  cost  of  such  service. 

The  investment  has  not  been  impaired  in  the  case  of  the 
sinking  fund  when  the  fund  is  equal  to  the  actual  accrued 
depreciation.  The  utility  has  the  investment  intact.  If  the 
investment  is  held  from  the  business  in  a  sinking  fund  and 
the  earnings  credited  to  the  fund,  costs  are  reduced,  the 
assets  in  the  fund  are  in  a  very  definite  sense  used  and  use- 
ful to  the  service,  and  the  company  is  entitled  to  receive 
a  return  upon  them  the  same  as  upon  any  other  part  of  its 
investment.  If,  however,  the  fund  is  not  intact  and  the 
money  has  been  devoted  to  other  uses,  the  utility  has  in 
effect  elected  to  secure  a  return  on  the  money  other  than 
that  provided  by  the  utility  service,  and  no  return  can  be 
allowed  in  the  utility  rates. 


216  FAIR  VALUE 

XIV.   The  Depreciation  Reserve 

The  proper  amount  to  be  held  in  reserve  to  meet  accruing 
depreciation  is  a  debated  question.  The  requirements  of 
each  type  of  utility  are  different.  The  requirements  of  indi- 
vidual utilities  of  the  same  type  vary  greatly.  The  problem 
is  always  a  local  and  an  individual  one.  The  uniform  sys- 
tems of  accounts  drafted  by  regulatory  bodies  have  for  the 
most  part  left  the  question  wholly  within  the  hands  of  the 
management,  providing  only  against  breach  of  the  spirit 
of  the  law  by  the  companies.  The  courts  have  wisely  taken 
no  fixed  stand  upon  the  question.  It  has  been  widely  con- 
sidered in  rate  cases,  but  as  an  individual  problem  depend- 
ent upon  the  particular  facts. 

The  nature  of  the  depreciation  fund,  too,  has  been  a  sub- 
ject of  considerable  controversy.  Some  accountants  advo- 
cate a  "fund,"  others  a  "reserve."  Both  systems  have  re- 
ceived commission  sanction,  though  the  weight  of  authority 
seems  to  favor  the  "reserve." 

The  character  of  the  funds  held  for  depreciation  was  not 
clearly  understood  during  the  early  years  of  regulation,  and 
many  utility  managers  persisted  in  considering  the  funds 
as  unrestricted  profit  available  for  dividends.  The  Federal 
Supreme  Court  dispelled  this  view  by  its  decision  in  Rail- 
road Commission  of  Louisiana  v.  Cumberland  Telephone 
and  Telegraph  Company. l  Reserves  held  against  deprecia- 

1  The  Court  said,  in  part:  "It  was  obligatory  upon  the  complainants 
to  show  that  no  part  of  the  money  raised  to  pay  for  depreciation  was 
added  to  capital,  upon  which  a  return  was  to  be  made  to  stockholders  in 
the  way  of  dividends  for  the  future.  It  cannot  be  left  to  conjecture,  but 
the  burden  rests  with  the  complainant  to  show  it.  It  certainly  was  not 
proper  for  the  complainant  to  take  the  money,  or  any  portion  of  it,  which 
it  received  as  a  result  of  the  rates  under  which  it  was  operating,  and  so 
to  use  it,  or  any  part  of  it,  as  to  permit  the  company  to  add  it  to  its 
capital  account,  upon  which  it  was  paying  dividends  to  shareholders.  If 
that  were  allowable,  it  would  be  collecting  money  to  pay  for  depreciation 
of  the  property  and,  having  collected  it,  to  use  it  in  another  way,  upon 
which  the  complainant  would  obtain  a  return  and  distribute  it  to  its 
stockholders.  That  it  was  right  to  raise  more  money  to  pay  for  depre- 
ciation than  was  actually  disbursed  for  the  particular  year  there  can  be 


DEPRECIATION  217 

tion,  whatever  their  form,  are  a  portion  of  the  utility's  prop- 
erty; but  they  are  an  encumbered  property.  The  utility 
holds  them  in  a  fiduciary  capacity.  The  money  has  been 
collected  from  the  public  for  a  specific  purpose  which  im- 
poses a  sort  of  trust  character  upon  the  reserve.  It  must  be 
held  by  the  company  for  the  benefit  of  the  public  as  well  as 
its  own  interest.  The  reserve  can  be  used  legitimately  only 
for  replacement  of  the  wasting  assets  against  which  it  is 
held.  This  does  not,  however,  mean  that  the  money  rep- 
resented by  the  reserve  must  be  held  intact  during  the 
interval  pending  the  retirement  of  the  original  asset. 

The  money  shown  in  the  reserve  need  not  constitute  an 
actual,  ever-present  fund.  There  is  no  necessity  of  keeping 
the  fund  in  the  bank  available  for  momentary  use.  It  should 
be  put  to  work  until  the  time  that  it  is  actually  needed.  The 
method  of  using  the  fund  must  be  optional  with  the  man- 
agement, but  there  would  seem  to  be  no  better  use  than 
that  afforded  by  their  reinvestment  in  the  utility  business 
itself  under  the  direct  control  of  the  management  at  a  profit 
as  well  as  interest.  A  public  utility  always  requires  a  consid- 
erable supply  of  floating  or  circulating  capital.  The  depreci- 
ation reserve  may  be  used  to  meet  this  requirement,  or  the 
funds  may  be  put  back  into  the  business  gradually  by  in- 
vestment in  additions  and  betterments. 

The  fact  that  the  actual  funds  will  not  be  available  when 
needed  to  make  the  replacement  of  the  property  against 
which  they  are  held  will  not  be  material  in  either  case;  pro- 
vided the  investment  in  additional  wasting  assets  has  been 
restricted  to  proper  capital  purchases,  and  no  part  of  the 
reserve  has  been  used  to  meet  maintenance  requirements 
or  other  operating  expenses.  The  money  will  have  been  ac- 
tually invested  in  the  business  to  meet  need  for  new  capital. 

no  doubt,  for  a  reserve  is  necessary  in  any  business  of  this  kind,  and 
so  it  might  accumulate;  but  to  raise  more  than  money  enough  for  the 
purpose,  and  place  the  balance  to  the  credit  of  capital  upon  which  to  pay 
dividends,  cannot  be  proper  treatment."  (212  U.S.  414, 424, 53  L.  ed.  577.) 


218  FAIR  VALUE 

The  replacement,  when  it  becomes  necessary,  therefore, 
may  be  charged  as  a  new  investment  because  the  under- 
taking now  requires  an  increase  in  permanent  capital.  The 
plant,  however,  must  be  valued  for  rate-making  purposes 
at  its  depreciated  value  to  make  this  use  possible.  Thus  in 
the  case  of  a  plant,  the  original  investment  on  which  was 
$10,000,  with  accrued  depreciation  of  $2000,  at  the  date  of 
valuation,  the  present  worth  would  be  $8000.  If  the  money 
had  been  withdrawn  from  the  depreciation  fund  and  used 
for  additions  and  betterments,  the  present  worth  would  be 
increased  to  $10,000.  If  the  plant  was  carried  on  the  books 
at  the  original  cost  and  the  investments  made  from  the  de- 
preciation fund  had  been  capitalized,  there  would  be  a  capi- 
talization of  $12,000  as  opposed  to  a  present  worth  of  only 
$10,000.  Such  a  condition  could  not  be  recognized  in  a  valu- 
ation for  regulatory  purposes;  but  it  could  be  avoided  either 
by  valuing  the  property  at  its  depreciated  value,  or  by  re- 
fusing to  capitalize  the  assets  acquired  by  investment  of 
the  depreciation  fund. 

The  money  represented  by  the  depreciation  fund  cannot 
be  capitalized  irrespective  of  the  use  made  or  to  be  made 
of  it,  unless  the  money  is  set  aside  as  a  specific  fund  and 
its  earnings  added  to  that  fund  as  they  accrue,  because  the 
investment  back  of  the  fund  has  been  withdrawn  from  the 
business  and  is  not  used  or  useful  in  rendering  the  service.1 

XV.  Summary 

In  valuing  the  property  of  a  public  utility  for  rate-making 
purposes  the  aim  is  to  determine  the  present,  unimpaired 
investment.  There  is  no  longer  any  denial  that  depreciation 
takes  place.  Both  physical  and  functional  depreciation 
are  considered.  It  is  immaterial  what  force  has  caused  the 
loss  in  value,  so  long  as  there  has  been  an  impairment  of 
investment.  The  loss  is  primarily  that  of  the  public.  The 
utility  is  unquestionably  entitled  to  collect  the  fund  from 
1  Valley  Natural  Gas  Co.  (Cal.)  P.U.R.  1918-C-l,  3;  etc. 


DEPRECIATION  219 

the  consumers  to  keep  the  property  intact.  If,  however, 
the  utility  fails  to  collect  such  a  fund,  or  collects  it  and  pays 
it  out  as  dividends,  or  collects  it  and  devotes  it  to  a  use 
other  than  the  replacement  of  the  wasting  assets  against 
which  it  is  held,  a  part  of  the  original  investment  has  been 
withdrawn  from  the  public  service  and  devoted  to  another 
use.  If  the  fund  is  collected,  held  intact,  and  credited  with 
its  earnings,  it  represents  a  legitimate  investment  which  is 
made  to  assure  continuous  adequate  service.  In  such  cases 
it  must  be  allowed  to  earn  a  return  from  the  utility  rates. 

The  proper  amount  of  the  reserve  is  a  question  of  fact 
to  be  determined  by  the  circumstances  in  each  case.  No 
two  companies  will  necessarily  be  best  served  by  the  same 
depreciation  figure. 

The  expedient  method  of  determining  depreciation  is  to 
some  extent  a  question  to  be  answered  by  the  circumstance 
of  the  particular  case.  The  straight-line  method,  however, 
has  been  found  most  widely  applicable  and  has  been 
adopted  by  a  majority  of  the  commissions. 


CHAPTER  IX 
THE  RETURN  ON  THE  INVESTMENT 

I.  Valuation  and  the  Rate  of  Return 

It  may  seem  out  of  place,  in  a  treatise  on  "fair  value," 
to  consider  the  rate  of  return  to  be  allowed  upon  the  rea- 
sonable investment  shown  by  the  valuation;  but  valuation 
and  return  are  so  interdependent  in  rate-making  that  nei- 
ther can  be  satisfactorily  considered  separately. 

The  determination  of  the  "fair  value"  of  a  public  utili- 
ty's property,  in  the  great  majority  of  cases,  has  been  a  step 
in  the  longer  process  of  determining  the  reasonableness  of 
rates.  The  limitation  imposed  upon  legislative  rate-making, 
by  the  application  of  the  due-process  clause  of  the  Four- 
teenth Amendment  to  rate  control,  placed  public-utility 
regulation  on  a  cost-of-production  basis.  Modern  rate  con- 
trol involves  the  fixing  of  rate  schedules.  So  long  as  the  rate 
fixed  is  a  "reasonable"  one,  the  State  acts  within  its  police 
power  and  the  control  is  legitimate.  When  rates  are  fixed 
below  the  point  which  allows  the  utility  to  earn  a  fair  re- 
turn on  its  reasonable  investment  in  property  used  and  use- 
ful in  the  public  service,  the  rates  are  not  "reasonable." 
The  power  of  eminent  domain,  not  the  police  power,  has 
been  exercised  in  such  cases.  The  State  has  passed  a  law 
which,  if  enforced,  would  take  service  for  the  public  use, 
to  the  value  of  the  difference  between  the  rate  fixed  and  the 
fair  worth  of  the  service  which  would  be  rendered.  The  law 
is  unconstitutional  because  it  contains  no  provision  for  pay- 
ment for  the  property  which  would  be  taken  if  the  law  were 
enforced. 

A  reasonable  rate,  under  this  forced  construction  of 
due  process,  consists  of  several  elements.  It  must  give  to 
the  utility  cost  of  service,  plus  interest  on  investment,  plus 


THE  RETURN  ON  THE  INVESTMENT     221 

profit.  Valuation  determines  the  first  of  these  elements. 
The  rate  of  return  determines  the  second  and  third. 

II.  The  Development  of  the  Return  Question 

The  decisions  of  the  Supreme  Court  relative  to  the  fair 
rate  of  return  show  the  same  gradual  change  that  marked 
the  development  of  the  valuation  doctrine.  They  started 
with  the  holding  in  the  Granger  Cases  that  the  Court  is 
without  jurisdiction  to  consider  legislative-made  rates  at 
all.  The  development  of  the  doctrine  of  judicial  review 
brought  the  question  of  rate  reasonableness,  and  with  it 
the  return  issue,  to  the  front.  The  early  cases  did  not  seem 
to  detect  the  necessary  connection  between  return  and  rea- 
sonableness. The  Court  was  feeling  its  way.  The  justices 
doubted  their  power  to  question  legislative  judgment.  Any 
return  above  operating  expenses  and  depreciation  which 
the  legislature  might  deem  expedient  was  considered  suffi- 
cient. The  Court  seemed  unwilling  to  interfere. 

The  question  of  return  came  before  the  Court  specifically 
first  in  Reagan  v.  Farmers'  Loan  and  Trust  Company,1 
wherein  Justice  Brewer  said: 

It  is  unnecessary  to  decide,  and  we  do  not  wish  to  be  understood 
as  laying  down  an  absolute  rule,  that  in  every  case  a  failure  to 
produce  some  profit  to  those  who  have  invested  their  money  in 
the  building  of  a  road  is  conclusive  that  the  tariff  is  unjust  and 
unreasonable.  And  yet  justice  demands  that  every  one  should  re- 
ceive some  compensation  for  the  use  of  his  money  or  property,  if 
it  be  possible  without  prejudice  to  the  rights  of  others. 

The  Court  then  proceeded  to  point  out  that  there  may  be 
circumstances  justifying  rates  which  produce  no  return 
for  the  operator  on  account  of  extravagant  expenditures, 
waste  in  management,  unjustifiable  salaries,  poor  judg- 
ment in  location  or  time  of  construction,  etc. 

The  issue  was  presented  next  in  Stanislaus  County  v. 
San  Joaquin  and  Kings  River  Canal  and  Irrigation  Com- 
1  154  U.S.  362,  14  Sup.  Ct.  180,  38  L.  ed.  1014. 


222  FAIR  VALUE 

pany,1  wherein  the  Court  held  that  it  was  not  confis- 
cation, nor  denial  of  equal  protection  of  the  laws,  to  fix 
water  rates  which  would  produce  a  return  of  six  per  cent 
upon  the  value  of  the  property  actually  used  in  rendering 
the  service. 

In  Willcox  v.  The  Consolidated  Gas  Company2  the  Court 
considered  the  question  again,  saying: 

There  is  no  particular  rate  of  compensation  which  must  in  all 
cases  and  in  all  parts  of  the  country  be  regarded  as  sufficient  for 
capital  invested  in  business  enterprises.  Such  compensation  must 
depend  greatly  upon  circumstances  and  locality.  Among  other 
things,  the  amount  of  risk  in  the  business  is  a  most  important  fac- 
tor as  well  as  the  locality  where  the  business  is  conducted  and  the 
rate  expected  and  usually  realized  there  upon  investments  of  a 
somewhat  similar  nature  with  regard  to  the  risk  attending  them. 

The  Court  held  that  six  per  cent  was  a  reasonable  return 
on  property  employed  in  rendering  gas  service. 

In  Knoxville  v.  The  Knoxville  Water  Company3  the 
Court  declined  to  consider  whether  four  per  cent  was  a  fair 
return  on  water  works  property,  because  the  evidence  was 
not  clear  that  the  return  would  be  reduced  to  this  point. 

No  definite  rule  as  to  the  amount  of  the  return  or  the 
elements  necessarily  included  in  it  has  been  laid  down. 
Each  case  necessarily  has  been  decided  on  its  own  facts. 

The  early  decisions  held  the  utility  to  a  low  rate  of  re- 
turn, but  the  valuations  were  not  strictly  made.  The  later 
commission  cases  have  been  more  painstaking  in  the  valua- 
tion and  more  liberal  in  the  rate  of  return.  The  courts  have 
always  been  more  lax  in  their  valuation  and  less  liberal  in 
the  return  allowed  than  the  commissions. 

III.  Elements  involved  in  the  Return 

There  has  been  considerable  confusion  among  writers 
upon  utility  rates  and  valuation,  as  well  as  in  the  decisions, 

1  192  U.  S.  201,  26  Sup.  Ct.  241,  48  L.  ed.  406. 

2  212  U.S.  19,  29  Sup.  Ct.  192,  53  L.  ed.  382.         a  212  U.S.  1. 


THE  RETURN  ON  THE  INVESTMENT     223 

as  to  what  constitutes  the  rate  of  return.  Mr.  H.  G.  Barker 

says: x 

It  is  obvious  that  capital  will  flow  into  a  field,  if  it  secures  (1) 
ordinary  local  interest  return,  plus  (2)  compensation  for  business 
risks,  plus  (3)  some  reward  for  the  actual  attention  required  from 
the  investor,  and  plus  (4)  the  possibility  of  more  or  less  profit 
above  these  other  factors  which  partake  much  of  the  nature  of 
mere  wages  of  capital  and  capitalists. 

This  classification  is  somewhat  more  minute  than  practical. 
The  courts  and  commissions  have  seldom  troubled  them- 
selves with  such  delicate  distinctions.  They  have  uniformly 
held  that  two  principal  elements,  interest  and  profits,  are 
involved  in  the  return.2 

The  sum  of  interest  and  profit,  though  not  fixed  by  law, 
is  necessarily  limited  by  economic  rules  so  long  as  the  un- 
dertaking is  dependent  upon  private  capital.  The  return 
must  be  equal  that  available  in  other  industries  where  the 
risk  is  the  same,  or  maintenance  will  be  neglected,  ad- 
ditions and  betterments  postponed,  and  eventually  the 
capital  will  be  drawn  from  the  utility  field.  It  is  true  that 
the  conduct  of  the  utility  by  private  capital  is  a  public  un- 
dertaking, and  that  society  as  a  whole  has  a  direct  proprie- 
tary interest  in  the  profits,  but  it  is  equally  true  that  such 
interest  is  non-enforceable  below  the  point  of  return  offered 
by  equally  safe  investments.  The  only  way  in  which  society 
can  reduce  the  return  below  that  point  is  by  decreasing  the 

1  Public  Utility  Rates  (1917),  p.  96. 

2  A  Federal  Court  states  generally  the  considerations  involved  in  the 
rate  of  return,  thus:  "In  fixing  the  measure  of  return  upon  property 
devoted  to  public  use,  regard  should  be  had  to  the  character  of  the  busi- 
ness, the  locality  and  the  risk,  whether  the  return  will  be  uniform  and 
secure;  whether  the  patronage  is  steady  or  fluctuating  and  quickly  re- 
sponsive to  financial  and  commercial  changes,  interest  rates  legal  and 
contractual  and  the  rates  customarily  sought  and  required  in  like  in- 
vestments in  the  locality;  if  a  railroad,  the  character  of  the  traffic,  whether 
largely  of  a  kind  dependent  upon  uncertain  conditions  or  so  diversified 
that  causes  affecting  part  will  not  greatly  affect  the  whole."  Missouri, 
Kansas  &  Texas  Railway  Company  v.  Love,  177  Fed.  493,  502. 


224  FAIR  VALUE 

risk  and  with  it  both  the  interest  and  profit  elements.  If 
the  social  interest  in  profits  is  to  be  fully  collected,  society 
must  take  over  the  business  and  directly  assume  the 
risks. 

IV.   The  Interest  Element  in  the  Return 

Rate  valuation  is  but  a  step  in  the  determination  of  the 
cost  of  producing  the  service.  The  angle  from  which  the 
question  is  approached,  however,  is  not  the  same  in  public- 
utility  and  industrial  cost  problems.  For  this  reason  rate 
valuation  has  been  able  to  avoid  the  scholastic  conflict 
stirred  up  by  the  Harvard  school  of  accountants  as  to  the 
expediency  of  including  interest  in  cost  figures.  Interest 
has  been  uniformly  excluded  from  operating  expenses  and 
treated  as  a  part  of  the  return  by  commissions  and  courts. 
So  far  as  regulation  is  concerned  there  is  absolutely  no  dif- 
ference between  interest  and  profit,  other  than  the  nature 
of  the  elements  on  which  their  allowance  is  premised.  Pro- 
vision for  neither  is  mandatory  in  the  absence  of  reasona- 
bleness in  expenditures,  location,  etc.  Both  must  be  pro- 
vided for  when  operation  has  been  above  reproach.  Money 
cannot  be  secured  for  any  undertaking  unless  a  certain  an- 
nual percentage  or  pure  interest  is  paid  for  its  use,  but  this 
is  equally  true  of  profit. 

The  interest  element  of  the  return  was  commonly  fixed 
by  the  courts,  in  the  early  cases,  at  the  legal  rate.1  The 
later  cases  have  realized  that  the  interest  rate  itself  is  af- 
fected by  the  risk  and  many  other  elements,  and  the  tend- 
ency has  been  to  consider  the  rate  of  return  as  a  whole, 
rather  than  to  separate  it  into  its  unit  parts. 

1  Pennsylvania  R.R.  Co.  v.  Philadelphia  Co.,  220  Pa.  St.  100,  68  Atl. 
676,  15  L.R.A.  (N.S.)  108;  Louisville  &  Nashville  R.R.  Co.  v.  Brown, 
123  Fed.  946;  Columbus  Railway  &  Light  Co.  v.  Columbus,  U.S.  Circuit 
Co.  (So.  Dist.  Ohio)  Eq.,  No.  1206;  Central  of  Georgia  Railway  Co.  v. 
Railroad  Commission  of  Alabama,  161  Fed.  925;  People  ex  rel.  Jamaica 
Water  Supply  Co.  v.  Tax  Comm.,  196  N.Y.  39;  etc. 


THE  RETURN  ON  THE  INVESTMENT     225 

V-    The  Risk  Element  in  the  Return 

The  element  of  risk,  as  applied  to  present-day  conditions, 
has  received  unmerited  attention  in  discussions  of  the  rate 
of  return.  The  hazard  element  is  dual.  The  "risk "  for  which 
the  rate  of  return  provides  compensation  may  be  defined 
as  the  inherent  hazard  of  the  public  service  which  subjects 
the  investment  therein  to  liability  of  loss.  Beside  this  there 
is  another  class  of  risks  due  to  possible  faults  of  manage- 
ment. Risks  of  the  first  type  must  be  considered  when  they 
are  present,  and  there  are  many  elements  of  such  risk  in- 
volved in  every  public-utility  operation;  but  there  is  prob- 
ably no  other  business  which  is  quite  so  free  from  the  or- 
dinary industrial  risks  as  the  public-service  undertaking. 

The  operation  of  the  risk  element  is  the  same  in  the  util- 
ity field  as  elsewhere.  Any  element  which  decreases  the  prob- 
ability of  a  steady  or  adequate  return  must  be  considered 
in  fixing  the  rate.  Thus  the  character  and  needs  of  the  con- 
sumers, the  location,  the  possibility  of  developing  the  terri- 
tory at  reasonable  cost,  the  presence  of  substitute  service, 
the  possibilities  of  development  in  the  industry,  actual 
competition,  etc.,  mistakes  in  construction  and  operation, 
accidents,  poor  judgment,  unexpected  failure  of  demand, 
inability  to  establish  financial  connections,  and  similar  op- 
portunities for  loss  are  commonly  encountered. 

The  greatest  industrial  risks  occur  in  the  competitive 
field  and  result  from  the  incessant  struggle  between  pro- 
ducers, price  wars,  over-production,  the  unsettled  state 
of  the  industry,  market  fluctuations,  and  changing  methods 
of  production.  These  risks  have  for  the  most  part  been  elim- 
inated in  the  public-utility  field. 

The  recognition  of  regulated  monopoly,  and  the  exten- 
sive elimination  of  competition,  have  done  much  to  make 
public-utility  investments  secure  and  the  return  on  them 
uniform  and  certain.  Many  circumstances  have  combined 
to  create  a  stable,  uniform,  constantly  increasing  demand 
for  service. 


226  FAIR  VALUE 

The  second  type  of  "risks"  are  those  which  arise  from 
poor  judgment,  improper  organization,  poor  location,  bad 
management,  unsound  financial  policies,  etc.,  rather  than 
from  any  danger  inherent  in  the  undertaking  itself.  Such 
risks  truly  affect  both  the  interest  and  profit  elements  of 
the  return,  but  they  are  properly  treated  in  a  regulatory 
programme  as  a  distinct  factor  in  return,  namely,  "the 
reward  for  efficient  management." 

The  industrial  risk  is  susceptible  to  approach  from  three 
angles,  the  risk  when  the  original  investment  was  made, 
the  risk  as  reflected  by  current  market  reports  on  the  com- 
pany's bonds  and  the  present  estimated  risk  in  case  of  re- 
production. 

The  first  approach  has  been  uniformly  rejected.  Expe- 
rience has  taught  that  the  past  return  has  in  most  cases  am- 
ply compensated  the  utility  for  the  original  hazard.1  Where 
this  has  not  been  true  most  commissions  have  preferred 
to  include  the  early  risk  in  the  allowance  for  going  value. 
The  nature  of  the  hazard  is  not  such  as  to  warrant  perpet- 

1  It  does  not  seem  out  of  place  to  suggest  also  that  many  of  the  early 
utility  risks  were  assumed  for  expected  return  other  than  that  to  be  de- 
rived from  the  legitimate  operation  of  the  business.  A  number  of  Amer- 
ica's great  fortunes  are  monuments  to  the  early  risk  in  the  public-service 
field.  Few  of  the  gigantic  risks  so  often  referred  to  in  the  case  of  the  rail- 
ways were  assumed  without  provision  for  tenfold  return  from  the  de- 
velopment of  land  held  by  the  profiteers,  without  government  aid  which 
in  itself  was  ample  guarantee  against  the  risk  assumed,  or  with  a  view  to 
multiplying  return  by  financial  manipulation,  reorganization,  etc.  The 
fact  that  the  payment  for  the  risk  may  have  been  misapplied  or  that 
present  holders  who  purchased  during  the  boom  took  their  stock  after 
the  "melon"  was  cut  can  scarcely  be  considered  justification  for  collect- 
ing for  the  risk  a  second  time. 

This  same  line  of  thought  leads  to  the  conclusion  that  many  of  the 
elements  of  risk  have  been  self-imposed.  Thus  the  report  of  W.A.  Gunter, 
special  master  in  the  South  &  North  Alabama  Case,  197  Fed.  595,  at 
page  84,  says:  "Railroad  business  is  confessedly  more  than  an  ordinarily 
risky  one.  The  roads  seldom  have  escaped  receivership  and  bankruptcy 
proceedings."  Chapters  of  Erie  and  memories  of  the  Alton  Reorgani- 
zation aid  much  in  understanding  these  failures  and  bankruptcies,  and 
are  potent  arguments  against  over-estimation  of  the  risk  element  in 
return. 


THE  RETURN  ON  THE  INVESTMENT     227 

uation  of  a  return  based  upon  it  long  after  the  risk  has 
ceased  to  exist.  Early  risks  and  early  losses  must  be  amor- 
tized, not  permanently  capitalized  against  the  public.  And, 
as  already  explained,  they  can  be  considered  only  on  a  con- 
clusive showing  that  they  actually  existed,  that  the  taking 
of  the  risk  was  reasonable,  and  that  no  reparation  has  been 
made. 

The  second  figure  is  that  which  would  make  the  market 
value  of  the  securities  substantially  equal  to  the  real  in- 
vestment. This  theory  has  not  been  definitely  stated  by 
the  commissions,  but  seems  to  have  been  acted  upon  in 
several  cases. 

The  third  angle,  from  which  the  question  of  return  is  ap- 
proached, is  that  along  which  the  general  economic  forces 
shaping  industrial  return  in  the  competitive  field  com- 
monly move.  It  has  been  universally  accepted  in  the  case 
of  utilities,  however,  not  because  it  fits  the  regulatory  the- 
ory best,  but  because  the  institution  of  private  operation 
forces  its  adoption.  So  long  as  capital  can  secure  a  higher 
return  at  equal  risk  elsewhere  it  will  not  be  invested  in  the 
utility  field.1 

VI.   The  Rate  of  Return 

Public-utility  risks  have  been  reduced  to  a  minimum,  and 
the  reduction  has  eliminated  the  necessity  for  speculative 
profits.  It  is  not  necessary  to  offer  large  returns  or  to  per- 
mit speculation  or  manipulation  of  securities  to  attract 

1  This  phase  of  the  problem  is  clearly  stated  by  the  New  York  First 
District  Commission  in  Queens  Borough  Gas  &  Electric  Company,  2 
N.Y.  P.S.C.  (1st  Dist.)  544,  thus:  "Various  standards  have  been  sug- 
gested for  determining  the  fair  rate  of  return.  The  one  which  in  our 
opinion  is  properly  applicable  to  this  case  is  that  the  rate  should  be  such 
that  investors  would  be  induced  to  provide  the  funds  with  which  to  con- 
struct and  extend  a  gas  and  an  electric  plant  within  the  area  in  question. 
If  the  State  were  to  fix  a  rate  below  this  standard,  capital  could  not  be 
secured.  If  investment  were  made  before  the  State  acted,  the  original 
capital  might  be  forced  to  remain,  but  additional  capital  could  not  be 
secured  unless  necessary  to  protect  the  first  outlay." 


228  FAIR  VALUE 

capital  to-day.  Government  bonds  bearing  three  per  cent 
interest  sell  at  a  premium  in  normal  times,  and  two  per 
cent  federal  securities  are  quoted  around  ninety-nine.1  City 
and  county  bonds  ordinarily  are  readily  sold  at  five  per 
cent  and  command  a  premium  at  six.  State  bonds,  and  the 
securities  of  the  more  substantial  railroad  and  industrial 
corporations,  bearing  interest  at  four  and  a  half  per  cent, 
sell  at  par.  And  the  seven  per  cent  preferred  stock  of  such 
companies  usually  nets  six  per  cent  on  the  market  price. 
Savings  banks  pay  three  and  four  per  cent.  And  the  legal 
rate  of  interest  is  usually  from  five  to  seven  per  cent.  The 
interest  rate  is  universally  low  where  the  risk  to  the  invest- 
ment is  small  and  the  return  certain. 

It  is  clear  from  this  survey  that  the  interest  rate  is  a 
variable  item.  Where  capital  moves  freely  the  rate  varies 
from  day  to  day  with  the  money  market  quotations.  The 
interest  rate,  if  separately  fixed,  is  purely  a  matter  of  busi- 
ness judgment.  Usually  no  attempt  is  made  to  determine 
it  apart  from  the  total  return. 

The  allowance  in  addition  to  the  interest  rate  necessary 
to  provide  a  fair  return  on  the  investment  need  not  be  large. 
The  average  public  utility  is  financed  to  a  great  extent  by 
bond  issues.  The  bondholders  receive  a  stipulated  per  cent 
on  their  funds  which  is  materially  below  the  return  re- 
ceived by  the  utility.  A  rate  of  return,  on  the  total  value 
of  the  property,  but  slightly  greater  than  the  interest  rate 
on  the  bonds,  will  afford  a  relatively  high  dividend  because 
the  profit  earned  on  the  borrowed  capital  will  be  distributed 
among  the  stockholders.  Thus,  where  one  half  of  the  cap- 
ital has  been  secured  by  bonds  bearing  five  per  cent,  a 
seven  per  cent  return  on  the  valuation  will  allow  a  nine 
per  cent  dividend.  If  the  bond  interest  was  six  per  cent,  an 
eight  per  cent  return  would  afford  a  ten  per  cent  dividend, 
etc. 

1  The  interest  rate,  of  course,  is  far  from  normal  during  the  present 
crisis.  The  figures  given  are  based  upon  estimated  normal  conditions. 


THE  RETURN  ON  THE  INVESTMENT     229 

No  definite  figure  of  return  can  be  stated.  Any  general 
deduction  from  the  decisions  would  be  most  misleading  be- 
cause the  elements  considered  in  the  return  vary  with  the 
method  of  valuation  used,  with  the  financial  policy  which 
the  utility  has  pursued,  and  with  the  managerial  ability 
which  it  has  displayed. 

VII.  Duplication  in  Valuation  and  Return 

The  amount  to  be  allowed  in  the  return  must  necessarily 
be  influenced  by  many  elements,  in  addition  to  the  finan- 
cial policy  of  the  utility,  which  are  peculiar  to  the  particu- 
lar case.  The  elements  to  be  considered  must  be  determined 
to  a  large  extent  by  the  valuation  methods  employed.  Many 
questions  considered  in  connection  with  the  determination 
of  the  fair  value  of  the  property  are  encountered  again  in 
the  consideration  of  the  return.  Development  costs,  going 
value,  and  franchise  value  are  the  principal  items  considered 
in  connection  with  the  "risk-of- the- undertaking"  element 
in  the  return.  If  such  values  have  been  fully  included  in  the 
valuation  they  cannot  be  allowed  a  second  time  as  a  factor 
in  the  rate  of  return,  irrespective  of  the  terms  under  which 
they  are  suggested.  If  early  losses  have  been  considered  in 
an  allowance  for  going  value,  the  investor  has  been  prac- 
tically compensated  for  the  risk  he  assumed,  and  the  re- 
turn need  cover  little  more  than  pure  interest.  In  short, 
if  the  risk  element  has  been  provided  for  under  any  allow- 
ance in  the  valuation,  it  is  eliminated  from  consideration  in 
the  return. 

VIII.  Reward  for  Efficient  Management 

One  of  the  principal  elements  which  makes  the  return 
vary  to  meet  the  facts  of  the  particular  cases  is  the  neces- 
sity for  rewarding  efficient  management.  The  rate  of  return 
is  a  sort  of  regulatory  balance  wheel.  Valuation  is  neces- 
sarily inaccurate  and  inflexible.  The  fixing  of  the  return 
affords  the  commission  an  opportunity  to  consider  the  equi- 


230  FAIR  VALUE 

ties  of  the  case  and  make  regulation  an  aid,  not  a  burden 
to  operation. 

When  a  utility  has  rendered  adequate  and  efficient  serv- 
ice in  an  enterprising,  up-to-date  manner,  has  met  the 
standards  fixed  by  the  regulatory  body,  and  otherwise  sat- 
isfactorily discharged  its  duties  toward  the  public,  the  rate 
of  return  must  recognize  the  efficiency  and  reward  it  to  the 
same  extent  that  the  same  degree  of  managerial  ability 
exerted  in  other  lines  of  industry  would  be  rewarded.  A 
well-managed,  progressive  utility,  which  has  taken  every 
step  to  render  adequate  service  at  the  lowest  cost,  to  de- 
velop its  territory  and  maintain  amicable  relations  with 
its  consumers,  must  be  allowed  a  greater  return  than  a  util- 
ity which  has  been  inefficiently  managed. x 

Careless  and  inefficient  management  has  been  actually 
penalized.2  Thus,  in  Re  Monmouth  Public  Service  Com- 
pany the  Illinois  Public  Utilities  Commission  said: 

This  Commission  has  heretofore  taken  the  position  that  finan- 
cial rewards  in  public-utility  enterprises  should  be  commensurate 
with  the  ability  displayed  in  their  management,  and  rates  of  re- 
turn approximating  seven  per  cent  have  been  frequently  permitted 
in  cases  wherein  the  stewardship  appeared  competent.  In  the  case 
at  bar,  the  record  discloses  that  normal  ability  has  not  been  dis- 
played in  the  management  of  petitioner's  gas  property  and  the 
standards  of  service  have  not  been  complied  with,  and  to  assume 
mediocre  stewardship  is  entitled  to  the  same  rewards  as  capable 
conduct  of  affairs  is  to  enunciate  a  doctrine  at  variance  with  the 
•jum  of  human  experience  and  with  principles  well  recognized  in 
the  business  world. 

The  reward  for  managerial  ability  and  economical  opera- 
tion is  but  the  injection  into  the  regulatory  programme  of 
a  substitute  for  the  incentives  offered  individual  initiative 
in  the  absence  of  rate  regulation. 

1  Warren  Light  &  Power  Co.,  5  111.  P.U.R.  72;  Union  Gas  &  Elec.  Co., 
5  111.  P.U.R.  205,  etc. 

2  Little  York  Elec.  Co.,  5  111.  P.U.R.  80,  P.U.R.  1918-B-120;  Mon- 
mouth Public  Serv.  Co.,  5  111.  P.U.R.  229;  etc. 


THE  RETURN  ON  THE  INVESTMENT     231 

EX.  Allowance  for  Surplus 

Following  the  report  of  the  Railroad  Securities  Com- 
mission to  the  President  in  1911,  the  utility  companies 
throughout  the  country,  particularly  the  railways,  sought 
to  enforce  the  incorporation  in  the  return  of  an  allowance 
to  create  a  "reserve"  or  surplus  to  provide  for  "improve- 
ments which  add  nothing  to  the  earning  capacity  of  the 
property  and  ought  not  to  be  the  basis  of  increased  cap- 
ital liability." » 

Such  an  allowance  cannot  be  justified  under  any  con- 
ceivable theory  of  regulation.  It  would  force  the  public  to 
donate  exchange  value  to  the  railway,  without  any  return 
for  the  compulsory  gift,  on  the  theory  that  the  asset  could 
not  be  included  in  the  rate  base.  If  the  expenditure  is  rea- 
sonably necessary  to  permit  or  promote  efficient  service, 
there  is  no  rule  of  valuation  which  would  exclude  it  in  rate 
cases.  If  the  expenditure  is  such  that  it  does  not  add  to  the 
service,  and  is  not  beneficial  to  the  consumers,  there  can  be 
no  justification  for  taxing  it  against  the  consumer,  espe- 
cially where  the  service  rendered  is  public.  If  such  an  ex- 
penditure can  be  truly  justified  on  any  ground,  it  will  be 
provided  with  ample  return  by  the  allowance  for  efficient 
management. 

X.  Summary 

The  consideration  of  the  rate  of  return  closes  the  study 
of  fair  value.  It  fixes  definitely  the  place  of  valuation  in  reg- 
ulation. It  clarifies  many  of  the  problems  of  valuation.  The 
determination  of  the  rate  of  return  supplements  the  valua- 
tion and  both  are  subsidiary  to  the  final  issue,  the  reason- 
ableness of  rates.  Many  of  the  problems  of  valuation  have 
been  raised  by  the  lack  of  understanding  of  the  elements  of 
return.  It  is  doubtful,  for  example,  whether  the  dispute 
over  going  value  would  have  ever  assumed  the  proportions 
it  has  if  the  return  to  be  allowed  upon  the  fair  value  of  the 
1  Report  of  Railroad  Securities  Comm.  (1911),  p.  30. 


232  FAIR  VALUE 

property  had  been  understood  by  commissions  and  utilities 
alike.  The  same  is  true  of  franchise  value. 

The  rate  of  return  acts  as  a  balance  wheel  to  make  regu- 
lation run  smoothly  by  adjusting  the  more  or  less  arbitrary 
rules  to  the  individual  cases,  and  by  counteracting  so  far 
as  possible  the  dangers  from  the  inevitable  inaccuracies  in 
the  estimates  of  value.  It  assures  the  investor  interest  on 
his  capital  proportionate  to  the  risk  he  assumes,  and  in 
addition  thereto  a  fair  profit  which  is  proportionate,  not 
only  to  the  risk,  but  to  the  quality  of  the  service  and  the 
nature  of  the  management. 

Regulation  seeks  to  secure  the  advantages  of  both  com- 
petition and  monopoly.  Valuation  keeps  the  rate  near  the 
reasonable  cost  of  production  and  allows  the  economies  of 
monopolistic  operation.  The  rate  of  return  provides  the  in- 
centive for  individual  initiative  which  regulation  would  de- 
stroy if  rates  were  based  on  absolute  cost. 


CHAPTER  X 
CONCLUSION 

The  diversity  of  subject-matter,  the  necessity  of  consider- 
ing the  divers  theories  of  many  independent  jurisdictions, 
and  the  confusion  in  valuation  law  and  practice  render  any 
consideration  of  "fair  value"  unavoidably  incoherent.  It 
seems  desirable,  therefore,  in  concluding  a  study  of  this 
subject,  to  direct  attention  to  the  fundamental  principles 
of  valuation,  its  aims,  and  the  general  trend  of  commission 
action,  with  a  view  to  leaving  the  reader  with  a  concise  idea 
of  the  nature  of  "fair  value." 

Confusion  will  be  avoided  if  the  following  prehminary 
points  are  kept  in  mind: 

(1)  That  the  public  utility  is  essentially  different  from  other 

industry; 

(2)  That  private  property  devoted  to  the  public  use  is  not  the 

same  as  other  private  property,  and  does  not  enjoy 
the  same  legal  protection; 

(3)  That  the  service  rendered  is  governmental  in  its  nature, 

and; 

(4)  That  the  purpose  of  regulation  is  curtailment  of  "private 

rights"  and  the  encumbrance  of  "private  property." 

"Fair  value"  is  concerned  chiefly  with  rate  value,  for 
that  value  exercises  a  direct  effect  on  all  value  for  regula- 
tory purposes. 

Modern  rate-making  is  a  type  of  cost-finding,  for  rates 
are  based  directly  on  the  cost  of  the  service.  That  cost  is 
made  up  of  three  items,  material,  labor,  and  burden.  Rate- 
making  considers  the  first  two  elements  in  the  allowance 
for  operating  expenses.1  Valuation  deals  with  the  burden 

1  Rent  may  be  an  operating  expense,  but  where  the  utility  owns  the 
building  and  collects  a  return  on  the  investment  in  it,  it  cannot  collect  a 
second  return  as  rent.  Interest  and  bond  discount  are  included  in  the 
return,  not  in  the  operating  expense. 


234  FAIR  VALUE 

or  "expense"  element.  An  appraisal  or  valuation  is  neces- 
sary in  cost-finding  for  two  reasons.  It  shows  burden,  and 
it  is  the  basis  on  which  return  is  figured.  It  may  clarify  mat- 
ters to  state  the  rate  elements  in  equational  form,  thus : 

(material  +  labor  +  maintenance  +  depre- 
ciation + taxes + insurance)  =  operating  expenses 

(working  capital  +  depreciated  value  of 

physical  and  intangible  property)     =fair  value 

(interest +profit)  =  rate  of  return 

fair  value 

operating  expenses  + ; =  reasonable  rate. 

rate  of  return 

The  appraisals  in  regulatory  and  industrial  cost-finding, 
while  they  serve  the  same  purpose,  are  drawn  on  different 
lines.  Industrial  and  public-utility  valuation  are  inherently 
different.  The  appraisal  of  the  industrial  plant,  under  com- 
petitive conditions,  involves  no  question  of  public  interest 
in  profits,  in  management,  or  in  service.  When  monopoly 
exists,  the  public  interest  is  not  the  same  as  that  affecting 
the  public-service  company.  Industrial  valuation  usually 
seeks  to  determine  market  value.  Public-utility  valuation, 
though  it  may  consider  market  value,  can  never  be  based 
upon  it  alone,  for  rate  value  is  not  based  on  market  value 
and  all  regulatory  value  is  influenced  by  the  rate  base. 

The  two  valuations  differ  even  when  cost  of  production 
is  the  ultimate  question.  In  one  case  a  speculative  under- 
taking is  considered,  in  the  other  speculation  is  excluded. 
The  treatment  of  appreciation,  depreciation,  experiment, 
provision  for  the  future,  property  not  used  or  useful,  ap- 
portionment of  expenses,  and  many  other  items  is  neces- 
sarily different  in  the  two  cases.  The  private  property  of 
the  public  utility  is  burdened  with  a  serious  encumbrance 
which  materially  decreases  its  value.  No  similar  encum- 
brance exists  in  the  case  of  the  industrial  plant. 

The  cost  of  production  sought  in  the  two  cases  is  itself 
dissimilar.  The  industrial  plant  figures  show  actual  cost. 
The  regulatory  figures  show  reasonable  cost. 


CONCLUSION  235 

The  general  economic  principles  applicable  in  the  un- 
regulated industrial  field  do  not  necessarily  have  applica- 
tion in  either  the  monopolistic  industrial  field,  under  present 
regulatory  conditions,  or  in  the  public-utility  field.  Values 
and  prices  in  the  one  case  are  economic;  in  the  other,  legal. 
The  governmental  character  of  the  service  and  the  recogni- 
tion of  monopoly  set  in  operation  political  and  legal  forces 
which  render  the  situation  wholly  dissimilar  to  that  in 
the  general  field  of  business.  The  laissez-faire  rules  of  the 
general  field  do  not  apply  to  the  anti-monopoly  aims  of 
regulation  in  the  monopolistic  industrial  sphere,  nor  to  the 
regulated  monopoly  conditions  of  the  public-utility  field. 
Economic  rules,  founded  on  competition  as  the  principal 
regulatory  force,  have  failed  to  direct  the  political  and 
legal  forces  which  sweep  the  utility  sphere.  Those  forces 
must,  therefore,  shape  the  economic  rules. 

The  first  of  the  laissez-faire  economic  concepts  which  is 
swept  away  by  political  and  legal  interpretation  is  the  indi- 
vidualistic idea  of  private  property.  In  its  place  is  set  up 
the  social  concept  which  recognizes  an  extensive  public  in- 
terest in  property.  The  stage  has  not  been  reached  where 
this  interest  is  fully  developed.  The  delegation  of  the  gov- 
ernmental function  to  private  individuals,  to  transfer  the 
risk  of  the  undertaking  to  private  capital  carries  with  it  as 
effective  a  check  upon  the  social  theory  of  property  and 
upon  regulation  as  the  individualistic  economic  and  legal 
theories  themselves.  So  long  as  the  business  is  dependent 
upon  private  capital,  the  individualistic  interests  must  be 
extensively  recognized  to  attract  capital. 

The  second  of  the  economic  theories  to  fall  by  the  way- 
side is  the  value  concept.  "Value"  in  regulation  does  not 
mean  "economic"  or  "exchange"  value  because  regulatory 
value  is  based  on  rate  value,  and  to  measure  rate  value  by 
capitalized  earnings,  as  exchange  value  is  measured,  in- 
volves the  vicious  circle.  The  fair  value  of  the  public-utility 
property  for  rate-making  purposes  is  the  present  unim- 


236  FAIR  VALUE 

paired  reasonable  investment  in  property  used  and  useful 
in  rendering  the  public  service. 

The  next  idol  overthrown  is  the  competition  panacea.  The 
superficial  assumption  that  the  monopolistic  nature  of  the 
public  utility  is  the  basis  of  the  distinction  between  public 
and  private  service,  and  the  equally  superficial  conclusion 
that  regulation  is  but  a  substitute  for  competition,  are,  per- 
haps, responsible  for  more  confusion  in  valuation  than  all 
other  theories  combined.  Such  an  approach  to  regulation 
problems  predestines  the  study  to  failure,  for  it  can  only 
mean  the  application  of  laissez-faire,  individualistic  rules 
to  a  sphere  created  for  the  express  purpose  of  avoiding  the 
operation  of  those  rules.  Competition  is  based  upon  private 
interest.  Regulation  is  based  upon  public  interest. 

The  development  of  the  valuation  theory  is  but  the  slow 
swing  of  the  conservative  arm  of  the  law  to  meet  the  changed 
ideas  of  that  body  which  moulds  the  law.  The  State  Public 
Utilities  Commissions,  in  direct  contact  with  the  situation, 
bound  by  no  volume  of  precedent,  bowed  beneath  the 
weight  of  no  judicial  conservatism,  and  held  in  check  by 
no  formal  procedure,  have  far  outdistanced  the  courts.  A 
consideration  of  the  comparatively  few  recent  cases  in 
courts  of  last  resort  indicates  that  the  path  blazed  by  the 
commissions  will  be  followed  by  the  courts  when  possible. 


SELECTED  BIBLIOGRAPHY 


SELECTED  BIBLIOGRAPHY 

General  Works  and  Pamphlets 

Allison  —  Should  Public  Service  Properties  Be  Depreciated? 

Bailly  —  The  Legal  Basis  of  Rate  Regulation. 

Barker  —  Public  Utility  Rates. 

Beale  &  Wyman  —  Railroad  Rate  Regulation.  2d  Ed. 

Briefs  filed  with  the  Interstate  Commerce  Commission,  Valuation 

Division. 
Collier  —  Public  Utilities. 

Collins  —  The  Fourteenth  Amendment  and  the  States. 
Cotton  —  An  Argument  Against  Official  Valuation  of  Railroad 

Properties. 
Erickson  —  Valuation  of  Public  Utilities. 
Floy  —  Valuation  of  Public  Utility  Properties. 
Foster  —  Engineering  Valuation  of  Public  Utilities. 
Hale  —  Valuation  and  Rate-Making. 
Hayes  —  Public  Utilities,  Their  Cost  New  and  Depreciation. 

—  Public  Utilities,  Their  Fair  Present  Value  and  Return. 
McFall  —  Railway  Monopoly  and  Rate  Regulation. 
McGehee  —  Due  Process  of  Law. 
Reeder  —  Validity  of  Rate  Regulations. 
Smalley  —  Railroad  Rate  Control. 
Taylor  —  Due  Process  of  Law. 
Vanderblue  —  Railroad  Valuation. 
Whitten  —  Fair  Value  for  Rate  Purposes. 

—  Valuation  of  Public  Service  Corporations. 
Wilcox  —  Principles  as  to  Franchise  Values. 
Wyman  —  Public  Service  Corporations. 

—  Railroad  Valuation  and  Rates. 
Young  —  Depreciation  and  Rate  Control. 

Articles  in  Periodicals 

Adams  —  Valuation  of  Public  Service  Utilities.  11  Am.  Econ. 
Ass'n  Quarterly,  184. 

Allison  —  Ethical  and  Economic  Elements  in  Public  Service 
Valuation.  27  Q  J.  Econ.  27. 

Baker  —  Valuation  of  Terminal  Lands.  8  Journal  of  Account- 
ancy, 239. 


240  SELECTED  BIBLIOGRAPHY 

Bauer  —  Depreciation  and  Rate  Control.  29  Q.J.  Econ.  362. 
Bonbright  —  Depreciation  and  Rate  Control.  30  Q.J.  Econ.  546. 
Brinckley  —  Why  Appraisal  is  not  Valuation.  72  Eng.  Rec.  515. 
Butler  —  Valuation  of  Railway  Property  for  Purposes  of  Rate 

Regulation.  23  J.  Pol.  Econ.  17. 
Davis  —  Depreciation  and  Rate  Control.  29  Q.J.  Econ.  362. 
Delano  —  Application  of  a  Depreciation  Charge.  16  J.  Pol. 

Econ.  585. 
Edgerton  —  Value  of  the  Service  as  a  Factor  in  Rate-Making. 

32  Harvard  L.  Rev.  516. 
Gray  —  How  Does  Industrial  Valuation  Differ  from  Public 

Utility  Valuation.  Utilities  Magazine,  January,  1917,  p.  26. 
Gray  —  The  Vagaries  of  Valuation.  4  Am.  Econ.  Rev.  18. 
Hale  —  The  Supreme  Court's  Ambiguous  Use  of  "Value"  in 

Rate  Cases.  18  Col.  L.  Rev.  208. 
Hansel  —  State  Valuation  of  Railroads.  185  N.  Am.  Rev.  485. 
Hayes  —  Original  Cost  v.  Replacement  Cost.  25  Q.J.  Econ.  616. 
Heilman  —  Principles  of  Public  Utility  Valuation.  28  Q.J.  Econ. 

269. 
Henshaw  —  State  Railway  and  Public  Service  Commissioners 

on  Railway  Valuation.  Utilities  Magazine,  March,  1916,  p.  4. 
Riggs  —  Problems  of  Railroad  Valuation.  13  Columbia  L.  Rev. 

582. 
Ripley  —  Physical  Valuation  of  Railroads.  29  Q.J.  Econ.  569. 
Robinson  —  Legal,  Economic   and  Accounting   Principles  In- 
volved in  the  Judicial  Determination  of  Railway  Passenger 

Rates.  16  Yale  Rev.  355. 
Sakolski  —  Valuation  of  Railroad  Right  of  Way.  6  Am.  Econ. 

Rev.  288. 
Swayze  —  Regulation  of  Railway  Rates  Under  the  Fourteenth 

Amendment.  26  Q.J.  Econ.  389. 
Thelen  —  Public  Utility  Rates,  a  Just  and  Scientific  Basis. 

2  Cal.  L.  Rev.  1. 


TABLE  OF  CASES 


TABLE  OF  CASES  CITED 

Advance  on  coal  to  lake  ports,  In  Re,  22  I.C.C.  604 84 

Aldnut  v.  Inglis,  12  East.  527 11 

Alleghany  Valley  St.  R.R.  Co.  v.  Greco,  (Pa.)  P.U.R.  1917-A  723 . .     14 

American  U.T.  Co.  v.  Western  U.T.  Co.,  67  Ala.  26 20 

Ames  v.  Union  P.  Ry.  Co.,  64  Fed.  165 58,  88,  110 

Ann  Arbor  R.  Co.  v.  Fellows,  236  Fed.  387 177 

Apple  v.  Brazil,  (Ind.)  P.U.R.  1915-C  561 134,  154 

Appleton  v.  Appleton  Water  Works  Co.,  5  W.R.C.R.  215.  110,  116,  191 
Appleton  Water  Works  Co.,  In  Re,  6  W.R.C.R.  97,  Affd.  154  Wis. 

121  .  159 

Ardmore  Water  Case!  I.P.U.c!  No.  4670 . . . . . . . . '. ! '. '. '. '. ..........     83 

Ashland  v.  Ashland  Water  Co.,  4  W.R.C.R.  273 134 

Atlantic  Coast  Line  v.  N.C.  Comm.,  206  U.S.  1,  51  L.  ed.  933 33 

Banker  v.  L.D.  R.R.  Co.,  89  Hun.,  (N.Y.)  202 16 

Bay  State  Rate  Case,  In  Re,  (Mass.)  P.U.R.  1916-F  221.136,  144,  167 

Bee  Bldg.  Co.  v.  Savage,  91  N.W.  716,  65  Neb.  714 63,  79 

Beekman  v.  Saratoga,  etc.  R.R.,  3  Paige  45 16 

Belcher,  etc.  Co.  v.  St.  Louis  G.E.,  101  Mo.  192, 13  S.W.  822, 8  L.R.A. 

801 21 

Beloit  v.  Beloit  Water,  Gas  &  Elec.  Co.,  7  W.R.C.R.  187 134 

Berlin  Elec.  Light  Co.,  In  Re,  3  N.H.P.S.C.  174.  95,  110,  115,  146,  173 
Birmingham  Mineral  R.R.  Co.  v.  Parsons,  100  Ala.  662,  13  So.  602.     20 

Bloodgood  v.  Mohawk  &  H.  R.R.,  18  Wendell.  1 16 

Blue  Hill  St.  R.  Co.,  (Mass.)  P.U.R.  1915-E  370 174,  204 

Bluefield  v.  Bluefield   Waterworks  &  Imp.  Co.,  (W.  Va.)  P.U.R. 

1917-E  22 117 

Bd.  of  Trade  v.  Mountain  Home  Tel.  Co.,  (N.Y.  2d  Dist.)  P.U.R. 

1916-C  688 133 

Bogart  v.  Wisconsin  Tel.  Co.,  (Wis.)  P.U.R.  1916-C  1020 84,  110 

Bonbright  v.  Corporation  Comm.  of  Arizona,  210  Fed.  44 153 

Boston  Beer  Co.  v.  Massachusetts,  97  U.S.  25 20 

Bound  Creek  Water  Co.,  In  Re 84 

Boyd  v.  Alabama,  94  U.S.  645 19 

Bradley  v.  Ohio  River,  etc.  R.R.  Co.,  78  Fed.  387      16 

Brass  v.  N.  Dakota,  153  U.S.  391,  14  Sup.  Ct.  857,  38  L.  ed.  757. . .  21 
Bridgeport  Natural  Gas  &  Oil  Co.,  In  Re,  (W.  Va.)  P.U.R.  1916-C 

253 84,  136 

Bronx  Gas  &  Elec.  Co.,  In  Re,  (N.Y.)  P.U.R.  1916-A  440 118,  136 

Bronx  Gas  &  Elec.  Co.,  In  Re,  (N.Y.  1st  Dist.)  'P.U.R.  1917-D 

777 1 10 

Brunswick  &  T.W.  Dist.  v.  Maine  Water  Co.,  99  Me.  371 84,  101 

Brymer  v.  Butler  Water  Co.,  179  Pa.  231,  36  Atl.  249 136 

i.Budd  v.  New  York,  143  U.S.  517,  12  Sup.  Ct.  468 16,  21,  54 

Buel  v.  Chicago,  M.  &  St.  P.  Ry.  Co.,  1  W.R.C.R.  324 133 

Buffalo  Gas  Co.  v.  Buffalo,  3  P.S.C.  2d  Dist.  (N.Y.)  553 110, 134 


244  TABLE  OF  CASES 

Butchers'  Union  Slaughter  House  Co.  v.  Crescent  City  Live  Stock 

Landing  Co.,  Ill  U.S.  746,  16  Wall.  36 20 

Butler  v.  Lewiston,  A.  &  W.  St.  Ry.,  (Me.)  P.U.R.  1916-D  25 

32,  84,  110,  199 

Camara  De  Comercie  v.  Manila  Elec.  R.  &  L.  Co.,  (P.I.)  P.U.R. 

1915-D  977 84,  174,  181 

Campbell  v.  Hood  River  Gas  &  Elec.  Co.,  (Or.)  P.U.R.  1915-D  855 

101,  154,  166,  174,  206 

Capital  City  Gaslight  Co.  v.  City  of  Des  Moines,  72  Fed.  829 105 

Cayuga  Power  Corp.  (N.Y.)  P.U.R.  1917-E  915 14 

-  Cedar  Rapids  G.L.  Co.  v.  City  of  Cedar  Rapids,  223  U.S.  665,  32 

Sup.  Ct.  389 182 

Central  of  Ga.  Ry.  v.  R.R.  Comm.  of  Ala.,  161  Fed.  925  224 

Central  of  Ga.  Ry.  v.  R.R.  Comm.  of  Ga.,  U.S.  Dist.  Ct.  Middle  Dist. 

Ala.  No.  261,  Equity 133 

Central  Pacific  R.  Co.,  In  Re,  (Cal.)  P.U.R.  1916-B  845 108,  166 

Charleston  v.  Omro  Elec.  L.  Co.,  (Wis.)  P.U.R.  1915-B  1 136 

Charles  Town  Water  Co.,  In  Re 84 

Chesapeake  &  P.  Tel.  Co.,  (Md.)  P.U.R.  1916-C  925 167,   199 

Chicago  &  G.T.R.R.  v.  Wellman,  143  U.S.  412,  12  Sup.  Ct.  400,  36  L. 

ed.  176 20,  54 

Chicago  &  Northwestern  Ry.  Co.  v.  Smith,  210  Fed.  632 150,  177 

Chicago,  B.  &  Q.  R.R.  v.  Chicago,  166  U.S.  226,  17  Sup.  Ct.  581 .  .     56 

Chicago,  B.  &  Q.  R.R.  Co.  v.  Iowa,  94  U.S.  155,  24  L.  ed.  94 9,  47 

Chicago,  etc.  R.R.  v.  Dey,  35  Fed.  866 60 

Chicago,  Milwaukee  &  North  Shore  Elec.  Ry.  Co.,  In  Re,  P.U.R. 

1918-A  388 144,  151,  174,  206 

Chicago,  Milwaukee  &  St.  P.  Ry.  Co.  v.  Ackley,  94  U.S.  179,  24  L.  ed. 

94 9 

Chicago,  M.  &  St.  P.  Ry.  Co.  v.  Minnesota,  134  U.S.  418,  10  Sup.  Ct. 

462 20,  52 

Chicago,  M.  &  St.  P.  Ry.  Co.  v.  Tompkins,  176  U.S.  167,  44  L.  ed. 

418,  20  Sup.  Ct.  336 20 

Chicago  North  Shore  Elec.  Ry.  Co.,  (111.)  P.U.R.  1918-A  388 

144,  174,  206 

Citizens'  Tel.  Co.,  In  Re,  (Ind.)  P.U.R.  1919-B  352 174 

City  Water  Co.,  In  Re,  (Mo.)  P.U.R.  1917-B  624 174 

Cleveland,  Cin.,  Chi.  &  St.  L.  Ry.  Co.  v.  Backus  154  U.S.  439 178 

Clyde  v.  Richmond  &  D.R.  Co.,  57  Fed.  436 84 

Coke  Products  Ass'n  of  Connellsville  v.  B.  &  O.  R.  Co.,  27  I.C.C. 

125 84 

Coles  Co.  T.  &  T.  Co.,  In  Re,  I.P.U.C.  Nos.  7280,  7313 14 

Colorado  F.  &  I.  Co.  v.  Southern  P.  Ry.,  6  I.C.C.  489 33 

Colorado  Springs  Light,  Heat  &  Power  Co.,  In  Re 84 

Columbia  v.  Watts  Engineering  Co.,  (Mo.)  P.U.R.  1915-B  921 

168,  169,  170 
Columbus  Ry.  &  L.  Co.  v.  Columbus,  U.S.  Cir.  S.D.  Ohio  Eq.  No. 

1206 224 

Commercial  Club  v.  Citizens  G.  &  L.  Co.,  (Ind.)  P.U.R.  1916-E  1 

110,  134 
Commercial  Club  v.  Mo.  P.  Util.  Comm.,  (Mo.)  P.U.R.  1915-C  1017 .  88 
Commercial  Club  v.  Terre  Haute  Waterworks,  (Ind.)  P.U.R.  1916- 

B  180 134 


TABLE  OF  CASES  245 

Commission  Cases,  116  U.S.  307,  6  Sup.  Ct.  834 48,  51,  53,  62 

Consolidated  Gas  Co.  v.  Wilcox,  157  Fed.  854 Ill 

Corona  v.  Corona  Home  T.  &  T.  Co.,  (Cal.)  P.U.R.  1915-F  1014 

173   193 

Cotting  v.  Goddard,  183  U.S.  79,  22  Sup.  Ct.  30 '    22 

Cotting  v.  Kansas  City  S.  Yd.  Co..  82  Fed.  850 58,  90 

Covington  Turnpike  R.R.  v.  Sanford,  164  U.S.  578,  17  Sup.  Ct.  198 

20,  55,  58,  60,  72 
Cripple  Creek  Water  Co.,  In  Re,  (Cal.)  P.U.R.  1916-C  788. .  110,  117,  171 

Croty  v.  Tomah  Elec.  &  T.  Co.,  (Wis.)  P.U.R.  1917-A  439. 211 

Crownover  Telephone  Co.,  In  Re,  (Neb.)  P.U.R.  1915-E  571 88 

Culver  v.  St.  Joseph  &  C.I.  Ry.,  (Mo.)  P.U.R.  1917-B  542 16 

Cumberland  T.  &  T.  Co.  v.  Louisville,  187  Fed.  637 203 

Danville  v.  Danville  Water  Co.,  178  III.  299,  53  N.E.  118,  60  Am.  St. 

Rep.  304 20 

Darlington  Elec.  Light  &  Water  Power  Co.,  In  Re,  5  W.R.C.R.  397  130 
Delaware,  etc.  R.R.  v.  Central  Stock  Yd.  Co.,  45  N.J.  Eq.  50, 6  L.R.A. 

855 21 

Denver  v.  Denver  Union  Water  Co.,  62  L.  ed 189 

Des  Moines  Gas  Co.  v.  Des  Moines,  199  Fed.  204  115 

Des  Moines  Gas  Co.  v.  Des  Moines,  238  U.S.  113,  59  L.  ed.  1244 

158,  182,  189 

Des  Moines  Water  Co.  v.  Des  Moines,  192  Fed.  193 203 

Dow  v.  Beidelman,  125  U.S.  680,  8  Sup.  Ct.  1028 51,  56,  58 

Dunham,  In  Re,  (Mo.)  P.U.R.  1916-E  544 110,  116,  174 

East  Bakersfield  Imp.  Ass'n  v.  San  Joaquin  L.  &  P.  Corp.,  (Cal.) 

P.U.R.  1916-C  830 155 

East  Hartford  v.  Hartford  Bridge  Co.,  10  How.  511 19 

Edwards  v.  Glen  Tel.  Co.,  (N.Y.  2d  Dist.)  P.U.R.  1916-B  940.  116,  167 
Ely,  City  of,  v.  Ely  Light  &  Power  Co.,  (Nev.)  24  Comm.  Leaf.  578  154 
Express  Rates,  Ind.  R.  Comm.  No.  495 79 

Fall  River  Gas  Works  v.  Bd.  of  Gas  &  Elec.  L.  Comm.  214  Mass.  529, 

102  N.E.  475 136 

Freeport  Water  Co.  v.  Freeport,  186  111.  179,  57  N.E.  862 20 

Ft.  Supply  T.  &  T.  Co.  v.  Pioneer  T.  &  T.  Co.,  P.U.R.  1917-A  188  38 
Fuhrmann  v.  Cataract  Power  &  Conduit  Co.,  3  P.S.C.  2d  Dist.  N.Y. 

656 79,  88,  146,  181 

Galena  Water  Co.  v.  City  of  Galena,  74  Kan.  624,  87  Pac.  735 179 

Geer  v.  Baltimore  &  Ohio  R.  Co 84 

Georgia  R.  &  Banking  Co.  v.  Smith,  128  U.S.  174,  9  Sup.  Ct.  47,  32 

L.  ed.  377 20,  52 

German  Alliance  Ins.  Co.  v.  Lewis,  233  U.S.  389,  34  Sup.  Ct.  612,  58 

L.  ed.  1011,  42  L.R.A.  (N.S.)  100 24 

Gloucester  Water  Supply  Co.  v.  Gloucester,  179  Mass.  365,  60  N.E. 

977 179 

Goezler  v.  Georgetown,  6  Wheat.  593 19 

Grafton  Co.  Elec.  Light  &  Power  Co.,  In  Re,  282A.T.  &  T.  Co., 

Comm.  Leaflets  533 84,  115,  155 

Grafton  Co.  Elec.  Light  &  Power  Co.,  In  Re,  (N.H.  Sup.  Ct.) 

P.U.R.  1917-E  345 156 


246  TABLE  OF  CASES 

Grafton  Co.  Elec.  Light  &  Power  Co.,  In  Re,  (N.H.)  P.U.R.  1916- 

E  879 155,  187 

Greensburg  v.  Westmoreland  Water  Co.,  (Pa.)  P.U.R.  1917-D  478 

118,  153,  174 

Haverhill  Gas  Light  Co.,  In  Re,  Mass.  Bd.  G.  &  E.L.C.  9  Ann. 

R.  90 136 

Herman  v.  Newton  Gas  Co.,  (N.Y.  1st  Dist.)  P.U.R.  1916-D  825 

164,  167,  173 

Hill  v.  Antigo  W.  Co.,  3  W.R.C.R.  623 79 

Holyoke,  City  of,  v.  Holyoke  Water  Power  Co.,  Ann.  Rep.  Mass.  G. 

&  E.  Light  Coram.  1903,  p.  77-82 179 

Indianapolis  Water  Co.,  In  Re.,  P.U.R.  1917-E  556 118,  146 

Indianapolis  Water  Co.,  In  Re.,  P.U.R.  1919-A  448 112,  115 

Interstate  Commerce  Comm.  v.  Chicago  Gt.  Western  R.  Co.,  14  Fed. 
1003 84 

Janesville  Water  Co.,  In  Re,  (Wis.)  P.U.R.  1915-A  178 199 

Joplin  &  Pittsburg  Ry.  Co.,  In  Re,  (Mo.)  P.U.R.  1919-B  366 174 

Kansas  City  Elec.  L.  Co.,  In  Re,  (Mo.)  P.U.R.  1917-C  728 118 

Kennebec  Water  Dist.  v.  City  of  Waterville,  97  Me.  185,  54  Atl.  6 

101,  179 

Kings  County  L.  Co.  v.  Willcox,  156  App.  Div.  N.Y.  603 63 

Knott  v.  Chicago,  B.  &  Q.  R.,  230  U.S.  474,  33  Sup.  Ct.  975 74 

Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1,  29  Sup.  Ct.  149 

90,  121,  203,  222 

LaCrosse  Gas  &  E.  Co.,  In  Re,  8  W.R.C.R.  138 130 

Lake  Forest  v.  Lake  Forest  Water  Co.,  I.P.U.C.  No.  2343  and  2275, 

P.U.R.  1915-D  1008 38,  106 

Lake  Shore  &  M.S.  Ry.  Co.,  I.P.U.C.  No.  2495 38 

Lake  Shore  &  M.S.  Ry.  v.  Ohio,  173  U.S.  285, 19  Sup.  Ct.  465,  43  L. 

ed.  702 20 

Lamar  v.  Intermountain  R.L.  &  P.  Co.,  (Col.)  P.U.R.  1918-B  86 .  174,  213 

Landon  v.  Lawrence,  (Kan.)  P.U.R.  1916-B  331 136 

Laurel  Fork  &  S.H.  R.  Co.  v.  West  Virginia  T.  Co.,  25  W.  Va.  324 .     19 

Lima  v.  Lima  T.  &  T.  Co.,  (Ohio)  P.U.R.  1916-E  670 166,  174,  206 

Lincoln  v.  Lincoln  Water  &  Light  Co.,  I.P.U.C.  No.  2496,  P.U.R. 

1917-B  1.  95,  99, 103,  108,  110,  112,  115,  117,  162,  168,  173,  174,  199 

Lincoln  Gas  &  Elec.  Light  Co.  v.  Lincoln,  223  U.S.  349 123 

Little  York  Elec.  Co.,  5  111.  P.U.R.  80 230 

Los  Angeles,  In  Re,  (Cal.)  P.U.R.  1916-F  593 136,  166 

Louisville  &  N.  R.R.  v.  Brown,  123  Fed.  946 224 

Louisville  &  N.  R.R.  v.  Kentucky,  183  U.S.  503,  22  Sup.  Ct.  95 . . . .  33 
Louisville  &  N.  R.R.  v.  R.R.  Comm.,  196  Fed.  800 Ill,  146 

Manitowoc  W.W.  Co.,  In  Re,  7  W.R.C.R.  71 63,  79,  88,  131,  159 

Mantua  Twp.  v.  New  Jersey  Gas  Co.,  (N.J.)  P.U.R.  1916-C  163..  .   164 

Marbury  v.  Madison,  1  Cranch  137,  2  L.  ed.  60 50 

Marin  Municipal  Water  Dist.,  In  Re,  (Cal.)  P.U.R.  1915-C  433 

134   154 
Marquis  v.  Polk  County  Tel.  Co.,  (Neb.)  P.U.R.  1915-C  140 '  108 


TABLE  OF  CASES  247 

Mayhew  v.  Kings  County  L.  Co.,  2  P.S.C.  (1st  Dist.)  N.Y.  659 

63,  88,  158,  169,  194 

McCullough  v.  Brown,  41  S.C.  247 21 

Meek  v.  Consumers'  Elec.  L.  &  P.  Co.,  (Mo.)  P.U.R.  1915-A  956. .  169 

Memphis  Cotton  Oil  Co.  v.  I.C.R.  Co.,  17  I.C.C.  313 84 

Mercantile  Trust  Co.  v.  Texas  &  P.  Ry.  Co.,  51  Fed.  529 177 

Metropolitan  St.  Ry.  Co.,  In  Re  Reorganization,  3  P.S.C.  (1st  Dist.) 

N.Y.  113 170,  173,  177 

Michigan  C.R.R.  v.  Michigan  R.R.  Comm.,  236  U.S.  615,  59  L.  ed. 

750 20 

Michigan  State  Tel.  Co.,  In  Re,  (Mich.)  P.U.R.  1918-C  81 179 

Middlesex  &  Boston  Rate  Case,  In  Re 116 

Minnesota  &  St.  L.  R.R.  v.  Minnesota,  186  U.S.  257,46  L.  ed.  1151, 

22  Sup.  Ct.  901 31,  73 

Minnesota  Rate  Case  (1st)  134  U.S.  418,  10  Sup.  Ct.  462 52,  54 

Minnesota  Rate  Case,  230  U.S.  352,  33  Sup.  Ct.  729 

73,  84,  123,  124,  145,  147,  150,  152,  181 

Minnesota  Rate  Case,  184  Fed.  765 169 

Mississippi  River  &  B.T.R.  Co.,  In  Re,  (Mo.)  P.U.R.  1918-C  321 . .  174 

Missouri,  Kans.  &  Texas  Ry.  Co.  v.  Love,  177  Fed.  493 223 

Missouri  Rate  Case,  230  U.S.  471 74 

Missouri  Southern  R.  Co.,  In  Re,  (Mo.)  P.U.R.  1916-C  607 

166,  177,  206 

Monahan  v.  Pacific  G.  &  E.  Co.,  (Cal.)  P.U.R.  1916-B  609 105 

Monmouth  Pub.  Serv.  Co.,  5  111.  P.U.R.  229 230 

Monongahela  Navigation  Co.  v.  United  States,  148  U.S.  312, 13  Sup. 

Ct.  622,  37  L.  ed.  463 190 

Monongahela  Water  Co.,  In  Re,  223  Pa.  St.  323,  72  Atl.  625 179 

Monroe  Independent  Tel.  Co.,  (Neb.)  P.U.R.  1917-E  471 117 

Montpelier  &  Barre  L.  &  P.  Co.,  In  Re,  P.U.R.  1916-B  973 156 

Mountain  States  Tel.  &  Telg.  Co.,  In  Re,  (Col.)  P.U.R.  1917-B  198 

166,  167 
Municipal  League  v.  Pacific  G.  &  E.  Co.,  21  A.  T.  &  T.  Co.  Comm. 

Leaf.  699  .  ,  146 

Munn  v.  Illinois," 04  U.S.  iis,  24  L.  ed.  72  '.'.'.'.'.'.'.WW  .WW".  .9,  16,  45 
Murry  v.  Pub.  Utilities  Comm.,  (Idaho  Sup.  Ct.)  150  Pacific  47, 

P.U.R.  1915-F  436 105,  204 

Nash  v.  Page,  80  Ky.  539,  44  Am.  Rep.  490 21 

Nat'l  Hay  Ass'n  v.  Michigan  C.R.R.  Co.,  19  I.C.C.  34 84 

Nat'l  Water  Works  Co.  v.  Kansas  City,  62  Fed.  853,  10  CCA.  653, 

27  L.R.A.  827,  27  U.S.  App.  165 178 

New  Orleans  G.  Co.  v.  Drainage  Comm.,  197  U.S.  453, 25  Sup.  Ct.  471  20 
New  York  &  N.E.  R.R.  v.  Bristol,  151  U.S.  556, 14  Sup.  Ct.  437,  38 

L.  ed.  269 20 

New  York,  Ontario  &  Western  Ry.  Co.  v.  Shaw,  143  N.Y.  App.  Div. 

811,  128  N.Y.  Sup.  177 150 

Norfolk  &  W.  Ry.  v.  Conley,  236  U.S.  605,  49  L.  ed.  745 32 

North  Coast  Water  Co.,  (Cal.)  26  Comm.  Leaf,  1161 146 

North  E.  Kans.  R.  Co.,  (Kans.)  P.U.R.  1916-B  925 32 

Northampton  Co.  Water  Co.,  (Pa.)  P.U.R.  1917-E  939 14 

Northern  Pacific  Ry.  Co.  v.  Duluth,  208  U.S.  583,  28  Sup.  Ct.  341,  52 

L.  ed.  630 20 

Northern  Pacific  Ry.  v.  N.  Dakota,  236  U.S.  585, 59  L.  ed.  735 .  .81,  32,  73 


248  TABLE  OF  CASES 

Ocean  County  Elec.  Co.,  (N.J.)  P.U.R.  1916-D  77 156 

Ocean  County  Elec.  Co.,  (N.J.)  P.U.R.  1915-B  601 173 

Oklahoma  Gin  Co.  v.  Oklahoma 84 

Olcott  v.  Supervisors,  16  Wall  693,  21  L.  ed.  382,  83  U.S.  678 10,  16 

Omaha  v.  Omaha  Water  Co.,  218  U.S.  180,  30  Sup.  Ct.  615 

63,  88,  179,  182 

Omaha  &  L.R.  &  L.  Co.,  (Neb.)  P.U.R.  1915-B  416 175 

Omaha  W.W.  Co.  v.  Omaha,  218  U.S.  180,  54  L.  ed.  991,  30  Sup.  Ct. 

615 175 

Oregon  R.  &  Nav.  Co.  v.  Clausen,  116  Pac.  7 63 

Oshkosh  Water  Works  Plant,  In  Re,  12  W.R.C.  R.602 88,  134,  159 

Oshkosh  W.W.  Co.  v.  R.R.  Comm,  152  N.W.  859,  P.U.R.  1915-D 

336 63 

Palo  Alto  Gas  Case,  10  Rate  Research  93 202 

Pearsall  v.  G.  Northern  Ry.,  161  U.S.  646,  16  Sup.  Ct.  705 20 

Peck  v.  Indianapolis  Lighting  &  H.  Co.,  (Ind.)  P.U.R.  1916-B  445.   154 

Peik  v.  Chicago  &  N.W.  Ry.  Co.,  94  U.S.  164,  24  L.  ed.  97 9,  46 

Pennsylvania  R.R.  Co.  v.  Philadelphia,  220  Pa.  St.  100,  68  Atl.  676, 15 

L.R.A.,  (N.S.)  108 224 

People  v.  N.Y.C.  &  H.  R.R.,  28  Hun.,  (N.Y.)  543 16 

People  ex  rel.  Jamaica  Water  S.  Co.  v.  Tax  Comm.  196  N.Y.  39.  . .  224 
People  ex  rel.  Kings  Co.  L.  Co.  v.  Pub.  Serv.  Comm.  210  N.Y.  479.  203 
People  ex  rel.  New  York,  Ontario  &  W.  Ry.  Co.  v.  Shaw,  143  App. 

Div.  N.Y.  811,  128  N.Y.  Supp.  177  177 

Petaluma  &  S.R.  Co.,  (Cal.)  P.U.R.  1915-C  742 168,  193,  194 

Piercy  v.  Citizens  G.,  E.  &  H.  Co.,  (111.)  I.P.U.C.  No.  4896 107 

Pillsbury  v.  Peoples  Gas  Light  Co.,  4  N.H.  P.U.C.  391 189 

Pine  Lawn  v.  W.  St.  Louis  Water  &  L.  Co.,  P.U.R.  1917-B  679 

118,  134,  167,  174 
Planters'  Compress  Co.  v.  Cleveland,  C.C.  &  St.  L.  Ry.  Co.,  11 

I.C.C.  382 84 

Planters'  Compress  Co.  v.  Mo.,  K.  &  T.R.  Co.,  11  I.C.C.  606 84 

Portage  v.  Portage  Water  Co.,  (Pa.)  P.U.R.  1917-D  17 118 

Portland  R.  Light  &  P.  Co.,  (Or.)  P.U.R.  1916-D  976 

106,  117,  154,  155,  166,  206 

Portland  R.  Light  &  P.  Co.,  (Or.)  P.U.R.  1917-D  962 156 

Potomac  Elec.  Power  Co.,  (D.C.)  P.U.R.  1917-D.  563 174,  211 

Poy  Sippi  Tel.  Co.,  (Wis.)  P.U.R.  1917-B  469 14 

Pub.  Serv.  Comm.  v.  Helena,  52  Mont.  527 20 

Pub.  Serv.  Comm.  v.  Pacific  P.  &  L.  Co.,  (Cal.)  P.U.R.  1915-A  88  154 
Pub.  Serv.  Comm.  v.  Pacific  P.  &  L.  Co.  (Wash.)  P.U.R.  1916-B  86  156 
Pub.  Serv.  Comm.  v.  Pacific  T.  &T.  Co.,  (Wash.)  P.U.R.  1916-D  947  110 
Pub.  Serv.  Comm.  ex  rel.  Seattle  v.  Lighting  Co.,  (Wash.)  P.U.R. 

1915-B  135 174 

Public  Service  G.  Co.  v.  Pub.  Ut.  Comm.,  87  Atl.  651,  85  N.J.  63, 

79 88 

Puget  Sound  T.  L.  &  P.  Co.  v.  Reynolds,  244  U.S.  574,  61  L.  ed.  1325    32 

Queens  Borough  G.  &  E.  Co.,  2  P.S.C.  (1st  Dist.)  N.Y.  544 

63,  88,  146,  227 

Racine  Water  Co.,  (Wis.)  P.U.R.  1917-D  277 171 

Railroad  Comm.  v.  P.  &  0.  C.  R.  Co.,  63  Mo.  269 16 


TABLE  OF  CASES  249 

Railroad  Comm.  of  Louisiana  v.  Cumberland  T.  &  T.  Co.,  212  U.S. 

414,  53  L.  ed.  577 216 

Railroad  Passenger  Rate  Case,  (Mass.)  P.U.R.  1915-B  362 33 

Reagan  v.  Farmers'  Loan  &  Trust  Co.,  154  U.S.  363,  14  Sup.  Ct.  180, 

38  L.  ed.  1014 20,  55,  51,  58,  99,  221 

Reagan  v.  Mercantile  Trust  Co.,  154  U.S.  413 55 

Redondo  Beach,  City  of,  In  Re,  (Cal.)  1915-B  429 154 

Rhinelander  v.  Rhinelander  L.  Co.,  9  W.R.C.R.  406 156 

Rich  v.  Biddeford  &  S.  W.  Co.,  (Me.)  P.U.R.  1917-C  982 134 

Ripon  v.  Ripon  Light  &  Water  Co.,  5  W.R.C.R.  1 134 

Rippe  v.  Black,  56  Minn.  108 21 

Rogers  Park  Water  Co.  v.  Fergus,  178  111.  571 20 

Roundup  v.  Roundup  Coal  Mine  Co.,  (Mont.)   P.U.R.   1916-D 

393 170 

Salem  Tel.  Co.,  In  Re,  (S.  Dak.)  P.U.R.  1919-B  734 136 

Salinas  City  v.  Coast  Valley  G.  &  E.  Co.,  (Cal.)  P.U.R.  1915-B  460 

166,  199 
San  Diego  Consolidated  G.  &  E.  Co.,  In  Re,  (Cal.)  P.U.R.  1917-A 

930  .   134 

San  Diego  L.  &  T.  Co.  i>.  Jasper,  110  Fed.  702! ........... '. 58 

San  Diego  L.  &  T.  Co.  v.  Jasper,  189  U.S.  439,  23  Sup.  Ct.  571,  47 

L.  ed.  892 118,  120,  131,  145 

San  Diego  L.  &  T.  Co.  v.  Nat'l  City,  74  Fed.  79 58 

San  Diego  L.  &  T.  Co.  v.  Nat'l  City,  174  U.S.  739,  19  Sup.  Ct.  804, 

43  L.  ed.  1154 20,  58,  71,  72,  119,  145 

San  Diego  W.  Co.  v.  San  Diego,  118  Cal.  556,  50  Pac.  633 

63,  110,  134,  144 

San  Gabriel  Valley  Water  Co.,  (Cal.)  P.U.R.  1916-B  895  134,  154 

San  Joaquin  v.  Stanislaus  County,  191  Fed.  875 177 

San  Joaquin  &  K.  R.  Canal  &  Irrigation  Co.  v.  Stanislaus  Power  &  L. 

Co.,  233  U.S.  454,  58  L.  ed.  1041 154 

San  Joaquin  L.  &  P.  Corp.  v.  R.  Comm.,  (Cal.  Sup.  Ct.)  P.U.R. 

1917-E  37 156 

San  Jose  Water  Co.,  In  Re,  (Cal.)  P.U.R.  1915-D  706 110 

San  Lorenzo  Water  Co.,  In  Re,  (Cal.)  P.U.R.  1915-D  1091 154 

Sandpoint  v.  Sandpoint  Water  &  L.  Co.,  (Idaho)  P.U.R.  1915-F  445 

134   154  204 

Santa  Cruz,  City  of,  In  Re,  (Cal.)  P.U.R.  1915-F  768 '....'  154 

Shepard  v.  No.  Pacific  Ry.  Co.,  184  Fed.  765 110,  133 

Simms  v.  Columbia  Tel.  Co.,  (Mo.)  P.U.R.  1915-C  356 171 

Simpson  v.  Shepard,  230  U.S.  352,  33  Sup.  Ct.  729 73,  84,  123,  124 

Sinking  Fund  Cases,  99  U.S.  700,  25  L.  ed.  496 45 

Slaughter  House  v.  Crescent  City  L.S.L.  Co.,  Ill  U.S.  746,  16  Wall 

36 20 

Smyth  v.  Ames,  169  U.S.  466,  18  Sup.  Ct.  418,  42  L.  ed.  819 

20,  58,  59,  72,  84,  90,  123,  144 

Southern  Minn.  R.R.  Co.  v.  Coleman,  94  U.S.  181 9 

Spokane  v.  N.  Pacific  Ry.  Co.,  15  I.C.C.  R.  376 136 

Spring  Valley  W.W.  v.  San  Francisco,  124  Fed.  574 63,  88 

Spring  Valley  W.W.  v.  San  Francisco,  192  Fed.  137 63,  88,  183 

Spring  Valley  W.W.  v.  San  Francisco,  165  Fed.  667 63,  101,  105,  190 

Spring  Valley  W.W.  v.  Schottler,  110  U.S.  347,  4  Sup.  Ct.  48,  24  L. 

ed.  173 20,  45 


250  TABLE  OF  CASES 

Springfield  v.  Springfield  C.  &  E.  Co.,  I.P.U.C.  No.  2138,  P.U.R. 

1916-C  281 95,  99,  110,  112,  115 

Stanislaus  County  v.  San  Joaquin  &  King's  River  Canal  &  Irrigation 

Co.,  192  U.S.  201,  26  Sup.  Ct.  241,  48  L.  ed.  406 121,  221,  222 

Stark  County  Power  Co.,  In  Re,  I.P.U.C.  No.  6704 88 

Stark  County  Tel.  Co.,  In  Re,  5  I.P.U.C.  63 89 

State  ex  rel.  v.  Clausen,  116  Pac.  7 63 

State  ex  rel.  v.  Savage,  65  Neb.  714,  91  N.W.  716 63,  79 

State  ex  rel.  R.R.  Comm.  v.  Seaboard  Air  Line  Ry.  Co.,  48  Fla.  129, 

37  So.  314 84 

State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501 

146,  169 

State  P.U.  Comm.  ex  rel.  v.  Noble,  275  111.  121 38 

State  P.U.C.  Comm.  ex  rel.  v.  Romberg,  (111.)  P.U.R.  1917-B  355  . .     38 
Steenerson  v.  Gt.  Northern  Ry.  Co.,  69  Minn.  353,  72  N.W.  713 

101,  110,  133,  146 

Stewart  v.  G.  Northern  Ry.,  65  Minn.  517 21 

St.  Louis  &  S.F.  R.R.  v.  Gill.,  156  U.S.  649, 39  L.  ed.  567, 15  Sup.  Ct. 

484 20,  32 

St.  Louis  &  S.F.  R.R.  v.  Mathews,  165  U.S.  1, 17  Sup.  Ct.  243,  41  L. 

ed.  611 20 

St.  Louis  &  S.F.  R.  Co.  v.  Hadley,  168.  Fed.  317 79,  190 

St.  Louis  R.  Co.  v.  Minn.,  186  U.S.  257 84 

Stockton  Terminal,  In  Re,  19  Com.  L.  208 79 

Stone  v.  Farmers'  L.  &  T.  Co.,  116  U.S.  307,  6  Sup.  Ct.  334 ..  .  48,  51,  53 

Stone  v.  Mississippi,  101  U.S.  814,  25  L.  ed.  1079 20 

Stone  v.  Wisconsin,  94  U.S.  181,  24  L.  ed.  102 9 

Sugar  Pine  R.  Co.,  In  Re,  (Cal.)  P.U.R.  1915-A  728 99 

Superior  Commercial  Club  v.  Duluth  St.  Ry.  Co.,  12  W.R.  C.R.  1  .  134 

Talcott  v.  Pine  Grove,  1  Flipp.,  (U.S.)  120 15 

Taylor  v.  Northwest  L.  &  W.  Co.,  (Idaho)  P.U.R.  1916-A  372 152 

Terminal  Taxicab  Co.,  In  Re,  (D.C.)  P.U.R.  1915-B  546 110,  174 

Thayer  v.  Beaver  Valley  Water  Co.,  (Pa.)  P.U.R.  1916-E  962.  .  134,  154 
Theresa  U.T.  Co.  v.  E.  Valley  T.  Co.,  (Wis.)  P.U.R.  1917-E  387. . .     38 

Tighe  v.  Clinton  Tel.  Co.,  3  W.R.C.R.  117 133 

Tilley  v.  S.F.  &  W.  Ry.,  5  Fed.  641 47 

Tonopah  &  Tidewater  R.  Co.,  In  Re,  (Cal.)  22  A.  T.  &  T.  Co.  Com. 

Leaf.  1064 177 

Tyrone  Elec.  Co.,  In  Re,  (111.)  P.U.R.  1916-E  708 83 

Union  Gas  &  E.  Co.,  5  111.  P.U.R.  205 230 

Union  P.  R.R.  v.  P.  Utilities  Comm.,  (Kan.)  P.U.R.  1915  -D  377..  32 

Union  Pacific  R.  v.  United  States,  99  U.S.  402,  25  L.  ed.  274 203 

United  States  v.  Kansas  Pac.  Ry.  Co.,  99  U.S.  459 203 

Valley  Natural  Gas  Co.,  (Cal.)  P.U.R.  1918-C 218 

Valparaiso  Tel.  Co.,  (Neb.)  P.U.R.  1915-E  578     136 

Vega  S.S.  Co.  v.  Consol.  E.  Co.,  75  Minn.  308,  77  N.W.  973,  43 

L.R.A.  843, 74  Am.  St.  Rep.  484 21 

Venner  v.  Chicago  City  R.R.  Co.,  246  111.  170 20 

Vogt  &  Linden  Tel.  Co.,  (Wis.)  P.U.R.  1917-A  614 14 


TABLE  OF  CASES  251 

Wabash,  etc.  R.R.  v.  Illinois,  118  U.S.  557 20 

Warren  L.  &  P.  Co.,  5  111.  P.U.R.  72 230 

Washburn   v.  Washburn  Water  Works  Co.,  6  W.R.C.R.  74 134 

Washington  &  M.R.  Co..  (D.C.)  P.U.R.  1915-B  558 105,  169,  173 

Westchester  St.  Ry.  In  Re,  3  N.Y.P.S.C.  (2d  Dist.)  286 80 

Western  Advance  Rate  Case,  20  I.C.C.R.  307 110,  146 

Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  29  Sup.  Ct.  192,  53  L. 

ed.  382 63,  64,  79,  88,  122,  145,  182,  192.  203,  222 

Winona  &  St.  Peter  R.R.  Co.  v.  Blake,  94  U.S.  181,  24  L.  ed.  99.  .  .  9 
Wisconsin  Ry.  Co.  v.  Jackson,  179  U.S.  287,  45  L.  ed.  194,  21  Sup. 

Ct.  115 33 

Worcester  v.  R.R  Co.,  4  Metcalf  564 16 


INDEX 


INDEX 


Abandoned  property,  70,  129-32. 

Accounting,  43. 

Accounts,  uniform,  43. 

Accrued  depreciation,  197,  198- 
200,  215,  218. 

Accruing  depreciation,  197,  198, 
199,  218. 

Actual  cost.  See  Original  cost. 

Actual  investment  theory.  See 
Actual  value. 

Actual  value,  56,  113-19. 

Adaptation,  175-77. 

Additions  and  betterments,  28, 
134-36,  208. 

Adequacy  of  service,  15,  28,  40. 

Adjacent  land  value,  139,  145. 

Age  of  plant,  206-07. 

Aims  of  regulation,  20-25, 27-44, 92. 

Aims  of  valuation,  56. 

Alvord's  reproduction  cost  theory, 
101-^04. 

Amortization,  165. 

Analogy.  See  Condemnation  anal- 
ogy- 

Annuity  method  of  estimating  de- 
preciation, 210-11. 

Anti-monopoly  regulation,  33-34. 

Antiquated  property,  129-32. 

Appraisals,  94-96. 

Appreciation,  141-45. 

Architects'  fees,  170. 

Assessed  value  of  land,  139-40. 

Attempt  to  discredit  original  cost, 
107-12. 

Average  buildings,  151-52. 

Average  prices.    See  Unit  costs. 

Ballast,  176. 

Banks,  regulation  of,  12. 
Basis  of  regulation,  1-26,  28. 
Beginning  of  operations.   See  Or- 
ganization costs. 
Betterments,  28,  134-35,  137,  208. 
Bonds: 

discount  on,  173-75; 

disregarded  in  rate  valuation, 
61. 


Book  value,  91,  97. 

Branch  lines,  return  on,  32. 

Bridges,  regulation  of,  10. 

Brokerage,  173-74. 

Buildings,  valuation  of,  151-53. 

Buildings   used   only   in   part   for 

service,  153. 
Business  profits.  See  Return. 
Bus  lines,  18. 

Canals,  10,  17. 
Capitalization: 

accounting  and  capitalization, 
43; 

consolidation,  43; 

of  earnings,  80; 

over-capitalization,  91; 

purchase  and  sale,  43; 

regulation  of,  43; 

reorganization,  43; 

valuation  based  on,  91,  92. 
Capitalization  of  earnings,  80,  89. 
Charges  for  service.  See  Rates. 
Charters,  early,  6. 
Commercial  value.  See  Exchange 

value. 
Commission  Cases,  48-51. 
Common  law,  5,  10,  12,  46. 
Communication      service,     public 

character  of,  18. 
Comparative  plant,  105-06. 
Competition: 

and  appreciation,  141-43; 

and  speculation,  39-41 ; 

as  a  regulatory  force,  13,  34, 
36-39; 

duplication,  13,  17,  36; 

effect  on  prices,  35-39; 

fostered  during  anti-monopoly 
period,  34; 

reason  for  change  to  monop- 
oly, 34-39; 

regulatory  power  of,  14,  35; 

waste  of,  13,  17,36,57. 
Compromise  reoroduction  theory, 

106. 
Condemnation,  63-73. 


256 


INDEX 


Condemnation  analogy: 

and  going  value,  64,  178; 

application  of,  63-73,  145; 

growth  of,  57-59,  74; 

origin  of,  57; 

theory  of,  57-59,  63-73. 
Condemnation    theory.    See   Con- 
demnation   analogy,  Due    pro- 
cess, etc. 
Condemnation  value,  63-73. 
Confiscation.  See  Due  process. 
Confusion  in  valuation,  45,  67,  76, 

138-39. 
Consolidation,  43. 
Construction  cost: 

architects'  fees,  170-71; 

contingencies,  147-49; 

contractors'  profits,  172-73; 

engineering  fees,  161,  163,  165, 
170-72; 

insurance,  161,  170; 

legal  expense,  167; 

multiples,  148-51; 

organization  expense,  166-67; 

piecemeal   construction,    175- 
76; 

promoters'  profits,  167-68; 

supervision,  163,  170-72; 

taxes,  161,  170. 
Construction  period,  168-69. 
Contingencies,  147,  148,  150. 
Continuous  service,  15,  28,  40. 
Contractor's  profit,  172-73. 
Contracts,  152-54. 
Corporations,  54. 

Cost.  See  also  Reproduction  cost, 
Original  cost,  etc. 

rate  valuation  determines  cost, 
81. 
Cost  of  production,  49,  56,  61,  72. 
Cost  of  reproduction.  See  Repro- 
duction cost. 
Cost  of  service,  56,  81,  84,  85. 
Circle.  See  Vicious  circle. 
Current  repairs.  See  Maintenance. 

Damages.  See  Multiples. 
Deferred  maintenance.  See  Depre- 
ciation. 
Depreciation: 

a  cost  element,  197-98; 
accrued,    197,    198,    199-200, 

214-15,  218; 
accruing,  197,  198,  200,  218; 


and  efficiency,  198-202; 

and  the  courts,  202-04; 

annuity  method,  210-11; 

buildings,  152; 

Colorado  theory,  213-15; 

confusion  with  efficiency,  198- 
202; 

defined,  196; 

diminishing  balance   method, 
209-10; 

estimated  life,  206-07; 

functional,  196-97; 

intangibles,  288-89; 

judicial  holdings  on,  202-04; 

maintenance  plan,  207; 

miscellaneous   methods,    212- 
13; 

of  intangibles,  205-06; 

physical,  196; 

problem  of,  198; 

reserve  for,  196,  215-18; 

salvage  value,  204-05; 

sinking-fund  method,  211-12; 

straight-line  method,  207-09; 

theory  of,  196,  198. 
Depreciation  of  overheads,  165. 
Depreciation  reserve,  197-98,  215- 

18. 
Deterioration,  196. 
Development  expenses,  166-67. 
Development  of  regulation,  4. 
Difference  between  inventory,  ap- 
praisal, and  valuation,  95. 
Diminishing    balance    method    of 

depreciation,  209,  210. 
Discarded  property,  129-32. 
Discounts.  See  Bond  discounts. 
Discrimination,  8,  29,  82. 
Donations,  133-34. 
Due  process: 

application  to  rate-making,  23, 
49,  74; 

Commission  cases,  48-51; 

confiscation,  23,  63-73; 

Granger  cases,  9,  45-48; 

operation  at  a  loss,  83; 

theory  of,  49-50. 
Duplication,  13,  15,  17,  36-39. 

Early  charter  provisions,  7. 
Earnings  capacity: 

in   purchase   and   sale   cases, 
88-90; 

in  rate  cases,  49,  90. 


INDEX 


257 


Earnings,  49. 

Economic    factors    in    valuation, 

77. 
Economic  management,  reward  for, 

81,  229-31. 
Economic  value,  78,  81,  92. 
Economist,  sphere  of,  in  valuation, 

94,  95. 
Efficiency: 

and  depreciation,  41,  198-202; 
economic  management,  41-42, 

229-31; 
false  capitalization,  41; 
necessity  for,  41-42; 
operating  expenses,  41 ; 
reward  for,  41,  81,  229-30; 
salaries,  42. 
Electric  plant  as  a  utility,  19. 
Emergency  use,  131-32. 
Eminent  domain : 

and  rate-making,  63-73; 
compared  with  police  power, 

66; 
condemnation  theory  of  val- 
uation, 63-73. 
Encumbrance    of    regulation,    11, 

26,  82. 
Engineer,  sphere  of,  in  valuation, 

94. 
Engineering  costs,  161,   163,   165, 

170-72. 
Equally  efficient  plant,  105-07. 
Established  business,  cost  of.  See 

Overhead  costs. 
Estimated  life,  206-07. 
Estoppel  to  deny  fair  return,  86. 
Excessive  investment,  131-32. 
Exchange  value: 

difference    between    rate    and 

exchange  value,  81; 
fair  value  not  exchange  value, 

80-82; 
limited  by  regulation,  92; 
value  defined,  77. 
Expert  witnesses  as  to  land  value, 

138-39. 
Express  service,  18. 

Facilities : 

donated    by    consumer,    133, 

135; 
rules  requiring  installation,  41. 
Factory   system    and    laissez-faire 
policy,  8. 


Fair  return: 

allowance  for  surplus,  231  f 
and  the  court,  220-22; 
development  of  return   ques- 
tion, 220-22; 
duplication  in  valuation  and 

return,  229-30; 
economic   management,    230- 

31; 
elements  involved  in  return, 

222-23; 
interest  element,  223-25;  } 
rate  of  return,  227-28; 
risk  element,  225; 
surplus,  231; 

valuation  and  the  return,  220. 
Fair    value.    See    also    Valuation, 
Original  cost,  etc. 
a  legal  concept,  45,  81 ; 
and  regulation,  45-76; 
as  a  test  for  individual  rates, 

73; 
condemnation  analogy,  57-59, 

63-73; 
confusion  regarding,  45,  67, 74; 
for  capitalization,  42,  79; 
for  purchase  and  sale,  42,  79, 

88-90; 
for  rate-making,  81-88; 
for  taxation,  79-80,  82; 
investment    theory  of,  87-88, 

113-19; 
meaning  of  value,  77-79,  82; 
not  exchange  value,  80-81 ; 
of  service,  72; 
rate-making  value,  81-88; 
theories  of  value,  96; 
varying  uses  of,  79-80. 
Ferries,  regulation  of,  10. 
Fifth  Amendment,  49. 
Fillings,  141. 

Financial  regulation,  42-43. 
Formula,  none  for  valuation,  125. 
Fourteenth    Amendment,    28,    44, 
46,  49,  63-73,  92,  94,  98, 144, 145, 
220. 
Franchises,  early  policy  regarding, 

7. 
Franchise  value,  189-93. 
Functional  depreciation,  196,  203. 
Future : 

construction  for,  129,  131-32; 
requirement  of,  131; 
water  rights  held  for,  154. 


258 


INDEX 


Gas  plant,  a  utility,  19/ 
Gifts,  183,  185. 
Going-concern  value,  180-81. 
Going  value: 

and  courts,  188-89; 

and  exchange  differential,  181- 
82; 

and  return,  230; 

comparative    plant    estimate, 
186-88; 

good-will,  182-84; 

in  general,  179-81 ; 

methods  of  estimating,  179; 

not  allowed  as  a  separate  ele- 
ment, 81,  186; 

origin  of  dispute,  178; 

past  deficits,  184-86; 

Wisconsin  rule,  184-86,  187. 
Good-will,  182-84. 
Government  control,  21-25. 
Government,  powers  of.  See  Rate- 
making  power. 
Governmental  function  theory  of 

regulation,  19-25,  8£. 
Grading,  141. 
Granger  cases,  9,  45-48. 
Granger  movement,  8. 
Grants,  7. 

Heating  service,  public  nature  of, 
19. 

Highways,  comparison  of  railways 
with,  10. 

Hypothesis.  See  Reproduction  cost. 

Hypothetical  expenses.  See  Re- 
production cost. 

Identical  plant.  See  Substitute 
plant. 

Improvements.  See  Additions  and 
betterments. 

Inadequacy.  See  Functional  de- 
preciation. 

Income.  See  Return. 

Individualism,  4,  7. 

Individual  rates,  73. 

Inns,  17. 

Insurance,  161,  170-71. 

Insurance  companies,  regulation  of, 
12. 

Intangible  property: 
adaptation,  176-77; 
architects'  fees,  170; 
attitude  of  court,  188-89; 


ballast,  176-77; 

comparative    plant    estimate, 

186-88; 
contingencies,  147-48; 
defined,  161; 

depreciation  of,  165,  205-06; 
discount  on  bonds,  173-75; 
engineering,  170-72; 
exchange  differential,  181-83; 
franchise  value,  189; 
going-concern  value,  179-81; 
going  value,  177,  189; 
good-will,  182-84; 
insurance,  170; 
interest   during   construction, 

167-70; 
multiples,  148-51; 
organization    expenses,    166- 

67; 
outlined,  162; 
overhead  charges,  161-65; 
past  deficits,  184-88; 
piecemeal  construction,   175- 

79; 
promoters'  profits,  166-67; 
seasoning,  176; 
solidification,  175-79; 
superintendence  and  engineer- 
ing, 170-72; 
taxes,  170; 

Wisconsin  rule,  184-86. 
Interest  during  construction,  161, 

167-70. 
Interest  element  of  return,  223- 

25. 
Inventory,  94-96. 
Invested  surplus,  135-38. 
Investment,    basis    of    valuation, 
86-88. 

Jeffersonian  dispute,  50. 

Judicial  legislation,  49-50. 

Judicial  limitation  on  rate-making. 
See  Judicial  review. 

Judicial  recognition  of  public  in- 
terest, 15-20,  29-31. 

Judicial  review,  50,  53,  55. 

Junk  value,  132. 

Jurisdiction  of  court  in  rate  cases, 
50,  59. 

Laissez-faire  policy: 

effect  on   court  decisions,  6, 
49; 


INDEX 


259 


in  early  American  law,  6; 
in  general,  6,  27,  49; 
Munn  case  limits,  11; 
reason  for,  7. 
Land  grants.  See  also  Public  aid. 
not  valued,  71; 
trust  theory  applied  to,  71. 
Land  value: 

appraiser  method,  138,  139; 
appreciation,  141-46; 
buildings  on  the  land,  140-41; 
local  expert  method,  138-39; 
market  value,  139,  146; 
original  cost  appraisal,  140; 
reproduction    cost    appraisal, 

146-51; 
sales  method,  138-39. 
Legal  expenses,  161. 
Legal  monopoly,  14. 
Legislative  power  over  rates,  49- 

50,  59-63,  74. 
Life  of  plant,  205-06. 
Lighting  service,  public  nature  of, 

19. 
Limitation  on  social  side  of  regula- 
tion, 29-33. 
Limitation  on  original  cost,  56,  72. 
Limitation  on  rate  of  return,  227- 

28. 
Limited  necessities,  supplying  is  a 

public  service,  19. 
Local  expert  land  valuation,  138- 

39. 
Losses,  184-86. 

Mains,  pavement  over.  See  Paving. 
Maintenance,  28,  197-98,  207. 
Maintenance  plan  of  depreciation, 

207. 
Management,  41-42,  81. 
Market  value,  61,  90-91.  151. 
Market  value  of  securities,  61,  73, 

90-91. 
Maximum  rate  laws,  33,  56. 
Methods  of  valuation,  90. 
Minimum   limit   on   rate-making, 

56,  61. 
Monopoly : 

anti-monopoly  regulation,  12, 

33-34; 
as  basis  for  regulation,  11-15; 
does  not  create  utility,  12; 
does   not  explain   purpose  of 
regulation,  13; 


early  regulation  of,  12; 

effect  of,  13; 

government  regulation  of,  12; 

legal,  13; 

natural,  14  n.; 

price,  12,  17; 

profits,  12; 

reason  for  acceptance  of,  14, 
36-39; 

recognition  of,  34-36; 

restraint  of,  12. 
Monopoly  price,  12. 
Monopoly  profits,  12,  23,  34. 
Multiples,  148-51. 
Munn  case,  9,  11,  15. 

Natural  monopoly,  14  n.,  36. 
Necessity  for  regulation,  15. 
Non-competitive  rates,  33. 
Non-operating  property,  129-32. 
Normal  cost  theory,_106-07. 
Normal  price,  35. 

Obsolescence,  196.  , 

Operation  at  a  loss,  83. 
Options.  See  Contracts. 
Organization  cost,  166-67. 
Original  cost : 

actual  cost,  56; 

attempt  to  discredit,  107-12; 

attitude  of  courts  toward,  110- 
12; 

book  value,  97; 

defined,  97-99; 

difficulty  in  applying,  108; 

estimation  of,  109; 

limitation  on,  56,  72; 

narrow  use  of  term,  91; 

objected  to  by  utilities,  107- 
12; 

reasonable  cost,  56; 

Smyth  v.  Ames,  109-12; 

theory  of,  97-99. 
Original-cost-to-date,  98. 
Over-capitalization,  92,  147. 
Overhead  charges: 

adaptation  and  solidification, 
175-77; 

architects'  fees,  170; 

attitude  of  court,  188-89; 

ballast,  176; 

book  value  of  overheads,  161; 

comparative    plant    estimate, 
186-88; 


260 


INDEX 


contingencies,  147-49; 
contractors'  profits,  171-73; 
depreciation  of  overheads,  165; 
discount  on  bonds,  173-75; 
duplication   in   allowance   for 

overheads,  161,  162-63; 
engineering  fees,  161,  163,  165, 

170-72; 
franchise  value,  189-93; 
going-concern  value,  179-81; 
going  value,  177-79; 
going  value  and  courts,  188- 

89; 
going     value     and     exchange 

differential,  181-82; 
going   value,   Wisconsin   rule, 

184-86; 
good-will,  182-84; 
insurance,  161,  170; 
interest    during   construction, 

161,  167-70; 
legal  expenses,  161; 
list  of  overheads,  162-63; 
multiples,  148-51; 
organization  expenses,  166; 
past  deficits,  184-86; 
piecemeal   construction,    175- 

76; 
promoters'  profits,  166-67; 
reproduction  cost  estimate  of, 

161,  164-65; 
seasoning,  176; 
solidification  and  adaptation, 

175-77; 
supervision,  163,  170-72; 
taxes,  161,  170; 
Wisconsin  rule  for  going  value, 

184-86. 

Past  deficits,  184-86. 
Past  profits.  See  Profits. 
Patrons  of  Husbandry,  9. 
Paving: 

actual  cost,  157; 

not  actually  cut,  157-58; 

original    cost  appraisal,   157- 

58; 
reproduction    cost    appraisal, 
113,  157-59. 
Physical  depreciation,  196. 
Physical  plant.  See  Tangible  prop- 
erty. 
Piecemeal     construction,     164-65, 
172,  175-76. 


Pioneer  risk,  226-27. 

Pipe  lines,  18. 

Pipes,  paving  over.  See  Paving. 

Pleading  and  practice  in  rate  cases, 

69. 
Police  power: 

cannot  be  contracted  away,  16; 

compared   with    eminent   do- 
main, 66,  75; 

effect  on  property,  4; 

extent  of,  66,  70; 

limitation  upon,  66,  70,  74; 

necessary,  16; 

negative  character  of,  27; 

public  interest,  4,  15; 

purpose  of,  19-20; 

restrictive  nature  of,  27; 

similar  to  eminent  domain,  66. 
Possession  distinguished  from  prop- 
erty rights,  4. 
Preliminary  expenses,  161,  165-73. 
Present  value.  See  Fair  value,  etc. 
Price  economics,  7. 
Private  ownership,  4,  31,  33,  84. 
Private  property.  See  Property. 
Profits: 

and  return,  224; 

and  surplus,  135; 

limits  on,  11,  82; 

past  profits,  82; 

public  interest  in,  11; 

regulation  of,  33,  56. 
Promotion,  7. 

Promotion  expenses,  166-67. 
Property : 

abandoned,  70; 

acquired   from   surplus,    134- 
38; 

acquired  without  cost,  133-34; 

and  the  state,  3,  19; 

appreciation,  141—46; 

a  social  institution,  4,  11; 

buildings,  151-53; 

bundle  of  rights  theory,  3,  11, 
143; 

constitutional  safeguards,  28, 
44,  46,  49,  143-44; 

contracts,  153; 

definition  of  private  property, 
3; 

destroyed  by  regulation,  27; 

distinguished  from  possession, 
4; 

donated,  133-36; 


INDEX 


261 


economic    status    of    private 
property,  3; 

encumbrance  of  control,    11, 
82; 

held  for  emergency,  131; 

held  for  future  needs,  132; 

intangible,  129; 

laissez-faire  doctrine,  6-7; 

land,  138; 

legal  status  of,  3,  83; 

limitation  on  use  of,  3,  4,  11; 

not  used  or  useful,  70,   129- 
32; 

origin  of,  4; 

original  cost,  140-41; 

paving,  157-59; 

private,  3-5; 

property  rights,  3-5; 

public   interest  in,  4,  11,  16, 
29-31; 

rate-making  a  limitation  on, 
11,  27,  82; 

regulation  and,  5; 

sanction  of  government  nec- 
essary to,  4; 

social  side  of,  4,  11,  16 ; 

two  sides  of,  4,  11; 

uses  of,  5; 

water  rights,  153-56. 
Property  rights,  3-5. 
Prospecting,  161. 
Provision  for  future,  132. 
Public  aid,  7. 

Public  interest,  3,  15-20,  29-31. 
Public  utilities: 

abuse  of  privileges,  7-9; 

ancient  utilities,  17; 

classified  separately  by  com- 
mon law,  5; 

development  of,  5; 

early  need  of,  6; 

early  utilities,  6; 

governmental  nature  of,   19- 
25; 

importance  of,  6; 

interest    not    antagonistic    to 
that  of  public,  29; 

laissez-faire  policy,  6; 

monopolistic,  14; 

need  for,  in  early  days,  6; 

regulation  of .  See  Regulation; 

under  common  law,  6. 
Purchase  and  sale: 

amortization  of  excess,  42; 


partial  sale,  42; 

price  limited  by   rate  value, 

42,  82; 
regulation  of,  42; 
sale  price,  42; 
valuation  for,  79,  82. 
Purpose  of  regulation,  23,  27-44, 

60,  73. 
Purpose  of  reproduction  cost  ap- 
praisal, 105-07. 

Rate  basis.  See  Valuation  for  rate- 
making. 
Rate-making  power: 

aim  of,  29,  83; 

Commission  cases,  48-51; 

Granger  cases,  9; 

limitation  on,  29-33,  74,  83; 

limitation  on  other  regulation, 
28; 

limitation  on  property,  27,  82; 

Regan  case,  55-57; 

valuation  as  base  of,  81-88. 
Rate  of  return: 

adjustment  to  social  needs,  32; 

allowance  for  surplus,  231; 

and  the  courts,  221-22; 

branch  line,  31; 

constitutional  requirement,  83; 

development  of  return   ques- 
tion, 221-22; 

duplication  in   valuation  and 
return,  229-30; 

economic  management,  81; 

elements   involved   in   return, 
222-23; 

interest  element,  223-25; 

limits  on  return,  227-28; 

must   be    met  on  each  rate, 
31-33,  73; 

rate  of  return,  32,  83,  227-28; 

risk  element,  225; 

surplus,  230; 

valuation  and  the  return,  83, 
220. 
Rate  regulation,  29-33,  41,  92. 
Rate  value,  83-88. 
Rates,  23,  29-33. 
Real  estate.  See  Land  value. 
Reasonableness : 

arbitrary,  23,  83; 

legislative  question,  23,  59,  61; 

original  cost,  56,  61,  72; 

test  of,  23,  84,  220-21. 


262 


INDEX 


Rebates,  8,  29. 

Recognition  of    regulated   monop- 
oly, 34-36. 
Regulation  : 

accounting,  43; 

aim  of,  23,  27,  44,  83; 

an    encumbrance    on    private 
property,  11,  26,  82; 

basis  of,  11,  23,  28; 

competition,  35,  36-39; 

destructive,  27; 

early,  4; 

effect    on    private    property, 
4,  5,  26,  27-28; 

encumbrance  on  private  prop- 
erty, 11,  26,  82; 

financial,  28,  42-43; 

limitation  on.  See  Rate-mak- 
ing power; 

monopoly  as  basis,  11; 

negative  in  character,  27; 

public  interest,  4,  11,  29-31; 

purpose  of,  23,  27-44,  60,  71; 

rate  of  return,  32; 

rates,  28,  29,  33,  45; 

restrictive,  5,  26,  27; 

service  requirements,  28; 

social  side  of,  4,  29-31; 

speculation,  39-41. 
Renewals,  198,  206-07. 
Reorganization,  43. 
Repairs,  28,  198,  206-07. 
Replacement  cost.  See  Reproduc- 
tion cost. 
Replacements.  See  Depreciation. 
Reproduction  cost: 

a  check  on  original  cost,  105; 

Alvord's  theory  of,  102-04; 

Ames  case  theory,  104 ; 

attitude  of  court,  111-12, 119- 
24; 

compromise  theory,  106-07; 

defects  of,  112-13; 

development    of    the    theory, 
100-05; 

economic  value,  81-82; 

market  value,  81-82; 

Minnesota  Rate  case,  123-24; 

normal  cost,  107; 

origin     of     the     reproduction 
theory,  92,  99; 

paving,  112-13,  157-59; 

purpose  of  reproduction  cost 
appraisal,  105-07; 


strained  theory,  111-13; 

substitute  plant,  105-06; 

Supreme  Court  and,  119-24; 

three  theories  of,  99-100. 
Reserve  for  depreciation,  206-07, 

215-18. 
Return.  See  Rate  of  return. 
Reward  for  economic  management, 

81. 
Risks  of  business,  142,  225-26. 
Road  bed.  See  Solidification. 
Rules  of  valuation,  95,  179. 

Sales  and  assessor  method,  138-39. 

Sales  method  of  valuing  land,  138- 
39. 

Salvage  value,  204. 

Saving-over-coal    value    of    water 
rights,  155-56. 

Scrap  value.  See  Salvage  value. 

Seasoning,  176. 

Securities,  43. 

Service,  15,  28,  40. 

Service,  value  of,  72,  83-85. 

Services,    installed    by    consumer, 
134-35. 

Sinking-fund  method  of  deprecia- 
tion, 211-12. 

Social  sacrifice  principle,  57. 

Social  side  of  private  property,  4, 
11,  16. 

Social  side  of  regulation,  4,  11,  16, 
29-33. 

Social  welfare,  29-33. 

Solidification,  176-77. 

Speculation,  8,  39-41,  142. 

Springs.  See  Percolating  waters. 

Standard  of  living,  30. 

State  aid,  7. 

State  regulatory  power.  See  Police 
power. 

Stocks.  See  Capitalization. 

Storage,  19. 

Straight-line  method  of  deprecia- 
tion, 207-09. 

Subsidies,  31. 

Substitute  plant  theory,  105-06. 

Substitute  service,  36. 

Superintendence,  163,  170-72. 

Surplus : 

allowance  for,  in  return,  231; 
invested,  135-38; 
property  acquired  from,  134, 
135-38. 


INDEX 


2G3 


Tangible  property: 

acquired  from  surplus,  134,138; 

acquired  without  cost,  133-38; 

appreciation,  141-46; 

buildings,  151-53; 

contracts,  153; 

defined,  129; 

land,  138; 

riot  used  or  useful,  129; 

original  cost,  140-41; 

paving,  157-59; 

reproduction  cost,  146-51; 

water  rights,  152-57. 
Taxes,  161,  170. 
Tax  value,  79. 

Telegraph  and  telephone,  18. 
Temporary  structures,  141. 
Threat  prices,  12. 
Title  not  taken  in  rate-making,  66. 
Transportation  service,  public  char- 
acter of,  19. 
Transportation  system,  importance 

of,  6,  17. 
Trust     theory    applied    to    land 

grants,  71. 
Turnpike,  regulation  of,  10,  18. 

Unearned    increment.   See  Appre- 
ciation. 
Unit  costs,  35. 
Unused  property,  70,  95,  129-32. 

Valuation.     See     also     Overhead 
charges,  Depreciation,  etc. 
actual  investment  theory,  56, 

113-19; 
a  judicial  theory,  45; 
a  legal  concept,  45,  81 ; 
and  economics,  77; 
and  regulation,  45-76; 
an  encumbrance,  27,  82-83; 
appraisal,  94; 

as  a  test  for  individual  rates,  73; 
as  cost  finding,  81; 
capitalized  earnings,  82; 
condemnation  analogy,  57-59, 

63-73,  70; 
confusion  in,  45,  67,  78; 
destructive  effect  of,  27,  83; 
development  of,  52,  56,  74-76; 
economic  features  of,  57,  80- 

82,  94-95; 
engineering  features  of,  94; 
exchange  value,  78,  80-81,  82; 


fair  value,  80-81; 

final  valuation,  94-96; 

for  capitalization,  79; 

for  purchase  and  sale,  79,  82, 
87-90,  191-93; 

for    rate-making,    79,    81-88, 
191-93; 

for  taxation,  79-80,  82,  191; 

growth  of,  74; 

inventory,  94-100; 

investment  theory,  86-87,  154, 
113-19; 

legal  features,  94; 

market  value,  82; 

meaning  of  value,  77-79; 

methods,  90-92; 

objective  value,  78; 

of  reproducible  objects,  99; 

origin  of  valuation,  56; 

original  cost,  97-99,  107-15; 

practice,  96; 

purpose  of,  71; 

rate-making  value,  81-88; 

reproduction      cost,      99-107, 
112-13,  119-24; 

steps  in,  94; 

subjective  value,  78; 

theories  of  value,  96; 

varying  uses  of,  79-80. 
Value: 

defined,  78; 

economic  value,  78,  80-81,  92; 

kinds  of,  79; 

legal  value,  80-81. 
Value  of  property.  See  Fair  value,  etc. 
Value  of  service,  72,  81,  84-85. 
Vested  rights.  See  Due  process. 
Vicious  circle,  64,  82. 

Warehouses,  regulation  of,   10-11, 

19,  45. 
Waste  of  competition,  13, 17,  36, 57. 
Water  power.  See  Water  rights. 
Water  rights,  152-56. 
Waterways,  17. 

Water  work,  public  character  of,  17. 
Wear,  197. 
Wells,  public,  17. 
Wharfinger,   public   nature   of   his 

service,  19. 
Wisconsin    rule    for    going    value, 

184-86. 
Working  capital,  161,  193-94. 
Worth  of  service,  57,  83,  84-85. 


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